Case Law Details
Brief of the Case
ITAT Mumbai held In the case of Inventurus Knowledge Services Pvt. Ltd. vs. ITO that it is clear that the eligible transactions in derivatives carried out through recognized stock exchanges are exempted from the purview of speculation transactions u/s 43(5) provided other conditions are satisfied. We have observed that the assessee company has entered into derivative transactions in foreign currency through SEBI registered broker who is a member National Stock Exchange of India Limited and these derivative transactions are carried on through National Stock Exchange of India which is a recognized stock exchange and these transactions are backed by time stamped contract notes carrying unique client identity number and PAN allotted under the Act. Thus we hold that these transactions are covered by the exception as contained in proviso (d) to Section 43(5) and hence are not speculative transactions as defined under Section 43(5).
Further as per AS -11 issued by ICAI, in situation like this when the derivative transaction in foreign currency has not been settled/squared during the accounting period, the effect of exchange rate difference on the un-expired foreign currency contracts as at the end of accounting period is to be accounted for in the books of accounts prepared for the afore-stated accounting period. It is not a notional or contingent loss rather it is an ascertained liability which has crystallized whereby a pending obligation of derivative contract on the balance sheet date is determinable with reasonable certainty and accuracy.
Facts of the Case
The assessee company is a KPO (Knowledge Process Outsourcing Unit) primarily involved in the business of Revenue Cycle Management (RCM) for their clients across US. During the course of scrutiny proceedings, the assessing officer observed that the assessee company has debited Rs. 1,09,98,560/- to the Profit & Loss Account on account of ‘loss on derivative transaction’ while the gross revenue was Rs. 5,83,80,537/- on account of services rendered to foreign clients. The assessee company was asked to explain such dis-proportionate loss as compared to gross revenue and the outstanding debtors as on 31- 03-2009. The assessee company submitted that during the financial year it has entered into foreign exchange derivative contracts on the National Stock Exchange of India Limited to hedge itself against foreign exchange fluctuations on account of underlying account receivables which are denominated in US Dollars. The assessee submitted that the loss on account of derivative transaction of Rs. 1,09,98,560/- representing loss arising out of restatement of foreign currency forward contract and mark to market losses on such foreign exchange derivative transactions as at the end of assessment year are booked in the books of accounts which are neither speculative nor contingent loss.
The assessing officer held these transactions of foreign exchange as speculative in nature and held that it falls within the ambit of section 43(5) and does not enjoys the benefit of proviso to section 43(5). The assessing officer held that it is for the assessee company to bring on record that this transaction is an ‘eligible transaction’ provided under Explanation 1 to section 43(5) and the same being a beneficial provision the onus is on the assessee company to bring on record cogent material to prove that its case falls within the four corners of the beneficial provisions. The assessing officer also held the said mark to market loss on the forward contracts of foreign exchange as contingent and notional loss and hence dis-allowable under the Act.
The assessing officer also noted that the assessee company has debited Rs. 10,31,096/- as Rates & Taxes out of which Rs. 2,59,000/- was paid as stamp duty and Rs. 7,45,286/- was paid to Ministry of Corporate Affairs, New Delhi as fees for increase in authorized capital. The assessing officer disallowed the said expenses u/s 37 being capital in nature and added back the same to the total income of the assessee.
Contention of the Assessee
The ld counsel of the assessee submitted that the loss on account of derivative transactions amounting to
Rs.1,09,98,560/- represents loss arising on account of restatement of foreign currency forward contracts in derivative segment in accordance with Accounting Standard-11 issued by ICAI and accordingly the assessee company has booked a marked to market loss of such foreign exchange derivative transaction. The assessee company submitted that it had done hedging by way of derivative transactions to protect against the loss arising on account of fluctuation between Indian Rupee and United States Dollar as its revenue are earned in US Dollars which are to be converted into Rupees, keeping in view its long term goals and achieved the turnover of Rs. 5.83 crores in the assessment year under consideration and Rs 35 crores in the succeeding assessment year.
The assessee company submitted that loss was neither speculative nor contingent and relied upon the following decisions:- 1. Shree Capital Services v.. ACIT 318 ITR 1, 2. CIT v. Woodword Governor India Pvt. Ltd. 312 ITR 254, 3. Oil and Natural Gas Corpn Ltd. v. DCIT 261 ITR 1 and 4. DCIT v. Bank of Bahrain & Kuwait 132 TTJ 505.
He further submitted that said loss is not speculative as the same is carried on the recognized stock exchange and are not deemed to be speculative in view of proviso (d) to Section 43(5) and also having complied with explanation 1 to section 43(5). He submitted that his case is covered in favour of the assessee company by the decision of Special Bench of the Tribunal in the case of DCIT v. Bank of Bahrain & Kuwait (2010) 132 TTJ 0505(SB). He also relied upon the decision of Hon’ble Supreme Court
in the case of CIT v. Woodword Governor India Pvt. Ltd. 312 ITR 254 and contended that these losses should be allowed to be set off against non-speculative business income being on revenue account as derivative contracts have foreign currency as underlying asset and these contracts are in the nature of stock-in-trade.
Contention of the Revenue
The ld counsel of the revenue submitted that these forward foreign exchange contracts are not backed by any business transactions and these are not hedging transactions and marked to market transaction cannot be allowed as per Instruction of CBDT no. 3/2010 dated 23th March 2010. The Ld DR relied upon the orders of Tribunal Mumbai in ITA no. 5631/Mum/2012 in Araska Diamond Private Limited to contend that these losses are speculative in nature and cannot be allowed to be set off against business income other than speculative income.
Held by CIT (A)
The CIT (A) held that these mark to market losses are notional losses as the amount of loss will not be known till the forward contract of foreign currency expires and hence the same cannot be allowed as deduction for the purpose of Income Tax Act even though the same may have to be provided in the books of accounts as per prescribed accounting standards. The CIT (A) further held the same to be contingent in nature and not allowable in view of CBDT instruction no. 17/2008 dated 26.11.2008.Thus, the CIT (A) disallowed the assessee company claim of Rs. 1,09,98,560/- on account of marked to market losses on forward contact entered into by the assessee company in foreign exchange .
Similarly regarding disallowance of payment to Ministry of Corporate Affairs of fee of Rs. Rs. 7,45,286/- and Stamp duty of Rs.2,59,000/- towards increase in authorized capital of the company , the CIT (A) rejected the contention of the assessee in view of the decision of Hon’ble Supreme Court in the case of Brooke Bond India Ltd. v. CIT (1997) 225 ITR 798 (SC), Punjab State Ind. Corp. Ltd. v. CIT (1997) 225 ITR 792 (SC) and CIT v.Kodak India Ltd. (2002) 253 ITR 445 (SC) and held the same expenditure to be capital in nature as the expenditure for expansion of capital retains the character of capital expenditure since it is directly related to the expansion of the capital base of the appellant.
Held by ITAT
It is clear that speculative transaction is a transaction in which contract for purchase and sale of any commodity is settled otherwise than by actual delivery. It is not in dispute that in case of transaction in derivatives, the transaction is always settled otherwise than by actual delivery. The derivative derives its value from underlying asset which can be securities, commodities, bullion, currency etc and in this instant case , the derivative transaction undertaken by the assessee company, the underlying asset of derivative transaction is foreign currency. The word ‘commodity’ is used in broadest sense in Section 43(5) as it mentions that the commodity includes stock and shares. Thus, derivative will be included in the definition of the word ‘commodity’ as held in Shree Capital Services Limited v. ACIT (2009)124 TTJ 0740(SBITAT Kol.). Hence, derivative transactions in foreign currency shall be exempted from purview of speculative transactions u/s 43(5) provided other conditions as contained in proviso (d) read with explanation 1 to Section 43(5) are fulfilled. Further it is clear that the eligible transactions in derivatives carried out through recognized stock exchanges are exempted from the purview of speculation transactions u/s 43(5) provided other conditions are satisfied because of recent and systemic and technological changes introduced by stock exchanges.
We have observed that the assessee company has entered into derivative transactions in foreign currency through SEBI registered broker who is a member National Stock Exchange of India Limited and these derivative transactions are carried on through National Stock Exchange of India which is a recognized stock exchange and these transactions are backed by time stamped contract notes carrying unique client identity number and PAN allotted under the Act. The reliance of the Ld. DR on the case of Araska Diamond Pvt. Ltd. is misconceived as in this case the assessee did not fulfill the conditions as stipulated under section 43(5) read with proviso and explanation thereto to entitle the assessee to bring forward contract in foreign currency within four corners of exemption from being treated as non-speculative transaction as per mandate of Section 43(5).
Thus, we hold that these derivative transactions in foreign currency as entered into by the assessee company duly fulfill all the conditions as specified u/s 43(5) read with proviso (d) and explanation 1 to Section 43(5). We further hold that these transactions are covered by the exception as contained in proviso (d) to Section 43(5) and hence are not speculative transactions as defined under Section 43(5). Thus, we hold that loss of Rs.1,09,98,560/- incurred by the company on derivative transactions in foreign currency is not a speculative loss within the definition as contained in Section 43(5).
Regarding contention of the Revenue that , these marked to market loss of Rs.1,09,98,560/- as at 31st March 2009 is a notional or contingent loss and cannot be allowed as revenue expenditure as in view of Revenue the assessee company has claimed the losses on unexpired derivative transactions in foreign currency based on the prevailing exchange rates of United States Dollar visà- vis in relation to Indian Rupee as on the date of Balance Sheet as at 31st March 2009 while the actual loss has not yet crystallized in the view of revenue because the derivative transactions had not yet been squared/settled as on the date of Balance Sheet as at 31st March 2009 , we are guided by the decision of Tribunal Special
Bench, Mumbai in DCIT v. Bank of Bahrain and Kuwait (2010) 132 TTJ 0505(SB), in which it was held that where a forward contract is entered into by the assessee to sell the foreign currency at an agreed price at a future date falling beyond the last date of accounting period, the loss is incurred to the assessee on account of evaluation of the contract on the last date of the accounting period i.e. before the date of maturity of the forward contract. The transaction in derivatives in foreign currency as entered into by the assessee company are similar to forward contract in foreign currency as discussed in the decision of Bank of Bahrain and Kuwait 132 TT 550] (ITAT Mumbai ). Respectfully following the decision of Tribunal, Special Bench, Mumbai in this case, we hold that the marked to market losses of Rs.1,09,98,560/- determined by the assessee company as on the date of Balance Sheet viz 31st March 2009 is not a notional or contingent loss rather it is an ascertained liability which has crystallized whereby a pending obligation of derivative contract on the balance sheet date i.e 31st March 2009 is determinable with reasonable certainty and accuracy .
The Accounting Standard-11 prescribed by ICAI also stipulate that in situation like this when the derivative transaction in foreign currency has not been settled/squared during the accounting period , the effect of exchange rate difference on the un-expired foreign currency contracts as at the end of accounting period is to be accounted for in the books of accounts prepared for the afore-stated accounting period. The reliance of the DR on instruction no 17/2008 dated 26th November 2008 is misconceived as in the instant case under appeal it is not a contingent or notional liability rather it is an ascertained liability which has crystallized and can be determined with reasonable certainty based upon the adverse exchange rate prevailing between United States Dollars vis-à-vis in relation to Indian Rupees as on the date of Balance Sheet as at 31st March 2009.
Hence, We hold that the said loss of Rs.1,09,98,560/- incurred by the assessee arising due to the adverse movement in the exchange cannot be considered as notional or contingent loss rather it is an ascertained loss which has already occurred during the assessment year which can be computed with reasonable certainty and accuracy and is a fait accompli as held in ONGC v. DCIT 261 ITR 1 –Delhi ITAT. We order that loss of Rs.1,09,98,560/- incurred by the assessee company on the contract for transaction in un-expired contracts as on the date of Balance Sheet as at 31st March 2009 in derivatives in foreign currency complies with the provisions of Section 43(5) of the Act read with proviso (d) and explanation 1 of the Section 43(5) is exempt to be categorised as speculation loss and further hold that the said loss as at the date of financial statement as at 31st March 2009 is not a notional or contingent loss rather it is a ascertained liability which has crystallized on the date of Balance Sheet as at 31st March 2009 and can be computed with reasonable certainty and accuracy, hence allowable as non-speculation loss. We order accordingly.
With regard to disallowance of payment to Ministry of Corporate Affairs, we observe that assessee company has paid Rs. 10,31,096/- towards stamp duty and fee to Ministry of Corporate Affairs, New Delhi towards increase in authorized capital of the assessee company which was held to be capital expenditure and disallowed as revenue expenditure as claimed by the assessee company by the authorities below . We have observed that Hon’ble Supreme Court in the case of Brooke Bond India Ltd. v. CIT (1997) 225 ITR 798 (SC), and Punjab State Ind. Corp. Ltd. v. CIT (1997) 225 ITR 792 (SC) has clearly held that these stamp duties/fees to Ministry of Corporate Affairs , GOI paid towards the increase in authorized capital of the company is held to be for expansion of capital base of the company and hence these are capital expenditure and cannot be allowed. Respectfully following the above decisions of the Hon’ble Supreme Court, we uphold the orders of assessing officer as confirmed by the CIT(A) and decide this issue against the assessee company and in favour of the Revenue by holding that payment of Rs. 10,31,096/- by assessee company towards stamp duty and fee to Ministry of Corporate Affairs, New Delhi towards increase in authorized capital of the assessee company is capital expenditure and disallowed as revenue expenditure as claimed by the assessee company . We order accordingly.
Accordingly appeal of assessee partly allowed.
