w w w . L a w y e r S e r v i c e s . i n



Quality Engineering & Software Technologies (P.) Ltd. v/s Deputy Commissioner of Income Tax, Bangalore


Company & Directors' Information:- R S SOFTWARE (INDIA) LTD. [Active] CIN = L72200WB1987PLC043375

Company & Directors' Information:- QUALITY ENGINEERING AND SOFTWARE TECHNOLOGIES PRIVATE LIMITED [Amalgamated] CIN = U72200KA1998PTC023481

Company & Directors' Information:- C K SOFTWARE PRIVATE LIMITED [Active] CIN = U72501DL2000PTC106184

Company & Directors' Information:- QUALITY TECHNOLOGIES PRIVATE LIMITED [Active] CIN = U28910TG1986PTC006138

Company & Directors' Information:- K K SOFTWARE PRIVATE LIMITED [Active] CIN = U72900DL2009PTC193030

Company & Directors' Information:- N I ENGINEERING TECHNOLOGIES PRIVATE LIMITED [Active] CIN = U26960TG2012PTC081434

Company & Directors' Information:- QUALITY INDIA PRIVATE LIMITED [Active] CIN = U25201UP1993PTC015433

Company & Directors' Information:- A K C SOFTWARE PRIVATE LIMITED [Active] CIN = U72200DL2004PTC128462

Company & Directors' Information:- P AND P SOFTWARE PRIVATE LIMITED [Active] CIN = U74899DL1994PTC057212

Company & Directors' Information:- S P SOFTWARE TECHNOLOGIES INDIA PRIVATE LIMITED [Active] CIN = U72200PN1999PTC014223

Company & Directors' Information:- SOFTWARE INDIA PRIVATE LIMITED [Active] CIN = U72200GJ1995PTC025791

Company & Directors' Information:- M S S ENGINEERING TECHNOLOGIES (INDIA) PRIVATE LIMITED [Active] CIN = U74140KA2004PTC035237

Company & Directors' Information:- N. D. SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200TG1998PTC029778

Company & Directors' Information:- SOFTWARE ENGINEERING INDIA PVT LTD [Strike Off] CIN = U99999MH1985PTC035066

Company & Directors' Information:- T AND H SOFTWARE PRIVATE LIMITED [Active] CIN = U72200UP2000PTC025638

Company & Directors' Information:- M S SOFTWARE PRIVATE LIMITED [Active] CIN = U72200DL2005PTC133997

Company & Directors' Information:- A T C SOFTWARE TECHNOLOGIES PRIVATE LIMITED [Strike Off] CIN = U74899DL1992PTC049696

Company & Directors' Information:- G A S SOFTWARE PRIVATE LIMITED [Active] CIN = U72200DL2004PTC127546

Company & Directors' Information:- B B SOFTWARE LTD [Strike Off] CIN = L30009WB1995PLC072361

Company & Directors' Information:- H K SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200WB2001PTC093967

Company & Directors' Information:- J SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200TZ2000PTC009229

Company & Directors' Information:- K S M SOFTWARE PRIVATE LIMITED [Active] CIN = U72200DL2004PTC128463

Company & Directors' Information:- R B SOFTWARE PRIVATE LIMITED [Active] CIN = U72200DL2005PTC140322

Company & Directors' Information:- SOFTWARE INDIA PRIVATE LIMITED [Active] CIN = U72200RJ1995PTC010577

Company & Directors' Information:- I-ENGINEERING SOFTWARE PRIVATE LIMITED [Active] CIN = U72200GJ1999PTC036497

Company & Directors' Information:- R J SOFTWARE PRIVATE LIMITED [Active] CIN = U72200DL2005PTC133815

Company & Directors' Information:- H J SOFTWARE PRIVATE LIMITED [Active] CIN = U72200TG2007PTC056351

Company & Directors' Information:- I & I SOFTWARE INDIA PRIVATE LIMITED [Strike Off] CIN = U72200TN2005PTC056262

Company & Directors' Information:- D F SOFTWARE INDIA PRIVATE LIMITED [Strike Off] CIN = U72200TZ2003PTC010629

Company & Directors' Information:- E. C. SOFTWARE INDIA PRIVATE LIMITED [Active] CIN = U72900TN2007PTC063486

Company & Directors' Information:- Q 3 INDIA SOFTWARE PRIVATE LIMITED [Active] CIN = U72900TN2007PTC065786

Company & Directors' Information:- K Y SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200DL2005PTC136072

Company & Directors' Information:- T M I SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200KA2005PTC036299

Company & Directors' Information:- B C L SOFTWARE (INDIA) PRIVATE LIMITED [Strike Off] CIN = U30007MH1999PTC117922

Company & Directors' Information:- C C M SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200TG2000PTC034002

Company & Directors' Information:- M I S SOFTWARE PRIVATE LIMITED [Active] CIN = U72200TN2008PTC068694

Company & Directors' Information:- A. T. SOFTWARE PRIVATE LIMITED [Active] CIN = U72200TG1996PTC023841

Company & Directors' Information:- J A K SOFTWARE PVT LTD [Active] CIN = U72200DL2001PTC111929

Company & Directors' Information:- R R SOFTWARE PVT LTD [Under Process of Striking Off] CIN = U72200KL1991PTC006051

Company & Directors' Information:- A M H SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200DL2005PTC132410

Company & Directors' Information:- P D A SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72900DL2003PTC123465

Company & Directors' Information:- K C SOFTWARE PRIVATE LIMITED [Active] CIN = U74899DL1989PTC036923

Company & Directors' Information:- E E SOFTWARE TECHNOLOGIES PRIVATE LIMITED [Active] CIN = U74140KA2003PTC031658

Company & Directors' Information:- I SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72300MH2012PTC225903

Company & Directors' Information:- L & B SOFTWARE TECHNOLOGIES PRIVATE LIMITED [Active] CIN = U74900MH2016PTC273934

Company & Directors' Information:- V M SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72900PN2010PTC136847

Company & Directors' Information:- S F SOFTWARE TECHNOLOGIES PRIVATE LIMITED [Active] CIN = U72300TG2015PTC101057

Company & Directors' Information:- H M SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200HP2011PTC031756

Company & Directors' Information:- S N R SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72900DL2012PTC243073

Company & Directors' Information:- K A V SOFTWARE PRIVATE LIMITED [Active] CIN = U72200DL2005PTC144121

Company & Directors' Information:- C M S SOFTWARE PRIVATE LIMITED [Active] CIN = U74899DL2005PTC142352

Company & Directors' Information:- S M I T SOFTWARE COMPANY PRIVATE LIMITED [Strike Off] CIN = U74899DL2006PTC144816

Company & Directors' Information:- A D SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200KA2002PTC030722

Company & Directors' Information:- TAX TECHNOLOGIES PRIVATE LIMITED [Active] CIN = U01100DL2020PTC366670

Company & Directors' Information:- H. A. N. R. E. J SOFTWARE PRIVATE LIMITED [Strike Off] CIN = U72200TG2008PTC062044

Company & Directors' Information:- K V V SOFTWARE TECHNOLOGIES PRIVATE LIMITED [Strike Off] CIN = U72200TG2008PTC062067

Company & Directors' Information:- G G SOFTWARE TECHNOLOGIES PRIVATE LIMITED [Strike Off] CIN = U72200AP2008PTC062342

    IT Appeal Nos. 257 & 275 of 2014

    Decided On, 14 November 2014

    At, Income Tax Appellate Tribunal Bangalaore

    By, THE HONOURABLE MR. N.V. VASUDEVAN
    By, JUDICIAL MEMBER & THE HONOURABLE MR. JASON P. BOAZ
    By, ACCOUNTANT MEMBER

    For the Appellant: Sriram Sheshadri, Advocate. For the Respondent: Priseilla Singsit, CIT-III (DR).



Judgment Text

Income Tax Appellate Tribunal, Bangalore Bench 'C'

Jason P. Boaz, Accountant Member

1. These are cross appeals, one by the assessee and one by Revenue, directed against the order of the Commissioner of Income Tax (Appeals)-III, Bangalore dt. 11.11.2013 for Assessment Year 2009-10. As both appeals arise out of the same order and pertain to the same assessment year, they are being disposed off by way of this common order. 2. The facts of the case, briefly, are as under :-

2. The facts of the case, priefly, are as under:-

2.1 The assessee, a company engaged in the business of providing computer aided engineering analysis and software services, filed its return of income on 30.9.2009 for Assessment Year 2009-10 declaring total income of Rs.28,48,96,860 after claiming deduction of Rs.75,000 under Chapter VI-A of the Income Tax Act, 1961 (hereinafter referred to as 'the Act'). The return was processed u/s.143(1) of the Act and the case was subsequently taken up for scrutiny. The assessment was completed under section 143(3) of the Act by order dt. 22.2.2013, wherein the income of the assessee was determined at Rs.44,91,86,187 as against the returned income of Rs.28,48,96,860 due to the following additions thereto / disallowances made :

(i) Disallowance of provision on loss on derivative contracts : Rs.16,35,54,352.

(ii) Disallowance u/s.14A : Rs.7,34,975.

2.2 Aggrieved by the order of assessment for Assessment Year 2009-10 dt. 22.2.2013, the assessee preferred an appeal before the CIT(Appeals) - III, Bangalore. The learned CIT (Appeals) disposed off the assessee's appeal by order dt. 11.11.2013 allowing the assessee partial relief. In this order, the learned CIT (Appeals) upheld the decision of the Assessing Officer in disallowing the provision for loss in derivative contracts. The learned CIT (Appeals), however, allowed the entire actual loss incurred in respect of derivative contracts in the period under consideration i.e. Assessment Year 2009-10 for the reason that the loss had been actually incurred and there is no logic in restricting the loss to the extent of provision created in the earlier year. On the issue of disallowance under section 14A of the Act, the learned CIT (Appeals) agreed with and upheld the finding of the Assessing Officer.

3. Aggrieved with the order of the learned CIT (Appeals) for Assessment Year 2009-10 dt. 11.11.2013, both revenue and the assessee are in appeal before this Tribunal raising the following grounds.

3.1 Assessee's Grounds of appeal

1. The order passed by the learned Commissioner of Income Tax (Appeals) - III ["CIT(A)"] in relation to the disallowance of provision for losses on derivative contracts and disallowance under provisions of section 14A of the Act read with Rule 8D of the Income-tax Rules, 1962 ("the Rules")is bad in law and on facts;

2. The learned CIT(A) has erred in law and on facts in upholding the disallowance made by the AO in respect of the provision for losses on derivative contracts of Rs 199,659,000 for the computation of business income computed under the normal provisions of the Act and in adding back the same for the computation of book profits under section 115JB of the Act;

3. The learned CIT(A) has erred in law and on facts in holding that the provision for losses on derivative contracts is unascertained and contingent in nature;

4. The learned CIT(A) has in law and on facts in not considering the announcement of Institute of Chartered Accountants of India on account of losses on derivative contracts dated March 29, 2008 and also that the appellant had duly adhered to the accounting principles and had accordingly provided for losses on derivative contracts;

5. The learned CIT(A) has erred in law and on facts in not appreciating that the principles of accounting should be applied for the purposes of ascertaining taxable profits of a business so long as they are not in contradiction with any express provisions of the statute;

6. The learned CIT(A) has erred in law and on facts by concluding that the provision for losses on forward exchange contract is not certain as the sale itself has not taken place;

7. The learned CIT(A) ought to have appreciated the fact that MTM foreign exchange losses of Rs 199,659,000pertaining to the unexpired forward contracts are on account of existing liability created against future sales that were determined with reasonable certainty;

8. The learned CIT(A) has erred in law and on facts in holding that the decision of the Honourable Supreme Court in the case of CIT v. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254 is not applicable in the case of the Appellant on the basis that the facts are completely distinguishable;

9. The learned CIT(A) has erred in law and on facts in not following the decision of the Mumbai Income Tax Appellate Tribunal (Special Bench) in the case of DCIT v. Bank of Bahrain & Kuwait (ITA No 4404 & 1883/MUM/2004), the facts of which squarely apply to the Appellant's case in hand;

10. The learned CIT(A) has erred in law and on facts in making disallowance under section 14A of the Act read with Rule 8D of the Rules of Rs 734,975 in the computation of business income;

11. The learned CIT(A) has erred in not appreciating the fact that the Appellant has not earned any exempt income by way of investment in equity shares of the companies either during the subject AY or in the prior years from the time that such investments were made;

12. The learned CIT(A) has erred in law and on facts by stating that the investments in the equity shares by the Appellant is a considerable part of the total assets and concluding that the Appellant would have incurred expenditure for earning of the exempt income;

13. The learned CIT(A) has erred in law and on facts by not appreciating the principle laid out by the jurisdictional Karnataka High Court judgment of CCI Ltd. v. JCIT [IT Appeal No 359 of 2011] wherein it was held that where there is no intention to earn exempt income, the notional expenditure cannot be disallowed under section 14A of the Act;

14. Without prejudice to the above, an amount of Rs 4,947,000 representing share application money (classified as investments)should not have been considered as investment for the purpose of making disallowance under section 14A of the Act read with Rule 8D of the Income Tax Rules, 1962.

15. The learned CIT(A) has erred in law and on facts in not commenting on the ground raised by the Appellant that the AO has made the above adjustments to both the income under normal provisions of the Act and to the income determined under the provisions of section 115JB of the Act; and

16. The learned CIT(A) has erred in law and on facts in not commenting on the ground raised by the Appellant that the AO has erred in law and on facts and circumstances of the case in re-computing the Minimum Alternate Tax under section 115JA of the Act to be Rs 7,969,982 by considering the enhanced income on account of certain disallowances for AY 2008-09;

17. The learned CIT(A) has erred in upholding the act of the AO to levy interest under section 234B of the Act;

18. The learned CIT (Appeals) has erred in upholding the act of the Assessing Officer to initiate penalty proceedings against the appellant by issuing notice under section 274 read with section 271 of the Act."

Additional Grounds

Further, the assessee vide letter dt. 17.7.2014 has filed two additional grounds, as under :

19. "Without prejudice to the existing grounds of appeal and the additional ground of appeal, that the Deputy Commissioner of Income-tax, Circle - 12(2), Bangalore ("the AO") be directed to allow corresponding adjustment and re-compute the amount of deduction towards actual losses on derivative contracts incurred by the appellant in the subject Assessment Year ("AY") 2009-10 by including the marked to market losses on derivative contract disallowed by the AO for the previous AY 2008-09.

20. Without prejudice to the existing grounds of appeal and the additional ground of appeal, that the AO be directed to allow carry forward of the losses arising on marking to market the derivative contracts, incurred during the subject AY 2009-10, for set-off against profits/ gains arising from derivative contracts in the future Assessment Years."

3.2 Revenue's Grounds of appeal.

"1. The order of the learned CIT (Appeals) is opposed to law and facts of the case.

2. On the facts and in the circumstances of the case the learned CIT (Appeals) erred in law in directing the Assessing Officer to allow the assessee a loss on speculation actually incurred by the assessee amounting to Rs.4,17,44,239.

3. On the facts and in the circumstances of the case the learned CIT (Appeals) erred in not appreciating the CBDT Instruction NO.3/2012 as per which the contracts in derivatives were clearly speculative ones and the provisions of section 73 of the Act do not provide for allowing the setting off the speculation loss against the income of the current assessment year and the speculative loss can only be allowed to be carried forward and set off against the income from speculation in future years.

4. For these and other grounds that may be urged at the time of hearing, it is prayed that the order of the CIT (Appeals) in so far as it relates to the above grounds may be reversed and that of the Assessing Officer may be restored.

5. The appellant craves leave to add, alter, amend and / or delete any of the grounds mentioned above."

Assessee's Appeal in ITA No.257/Bang/2014 (A.Y. 2009-10)

4. Provision for loss on derivative contracts : Rs.19,96,59,000.

4.1 The Grounds raised at S. Nos.1 to 9, by the assessee are in respect of the issue of disallowance of provision for losses on derivative contracts amounting to Rs.19,96,59,000 by the learned CIT (Appeals).

4.2.1 The facts of the matter as emanate from the record are that in the course of assessment proceedings, the Assessing Officer observed that the assessee has debited an amount of Rs.19,96,59,000 as provision for loss on derivative contracts. The assessee contended that in order to hedge against foreign exchange fluctuations and to limit the diminution in the value of export proceeds on services provided to overseas customers, the assessee had entered into forward contracts. As there was a strong depreciation in the value of Indian Rupee vis--vis the US Dollar, the assessee incurred significant losses which were provided for in the Books of Account, as per the requirement of Accounting Standard-11 ('AS'). As regards the allowability of this unrealised foreign exchange losses arising out of forward contracts, the assessee relied on the requirements of AS-11 and the decision of the Hon'ble Apex Court in the case of CIT v.Woodward Governor India (P.) Ltd. [2009] 312 ITR 254/179 Taxman 326.

4.2.2 The Assessing Officer, however, rejected the contention of the assessee and disallowed and added back the provision amount, in computing both the income under the normal provisions of the Act and also in the computation of 'Book Profits' under section 115JB of the Act, after making the following observations :-

(i) The forward contracts (foreign exchange derivatives) are to hedge loss on expected future sales;

(ii) The loss reported is not on account of re-statement of existing liabilities and assets, as discussed in the cases decided by the Hon'ble Apex Court;

(iii) Future sales are uncertain and hedging such future sales through forward contracts is purely a speculative transaction;

(iv) Loss not arising out of regular business transactions and also not on account of re-statement of assets and liabilities is only speculative loss and cannot be allowed as expenditure.

(v) CBDT Instruction No.3/2010 has laid down the guidelines that whenever there is no sale or settlement, the losses on financial instruments on MTM basis are notional losses and contingent in nature and cannot be allowed to be set off against taxable income.

4.2.3 On appeal, the learned CIT (Appeals) upheld the decision of the Assessing Officer in adding back the provision by relying on the decision of her predecessor for Assessment Year 2008-09. The relevant points made in the order of the earlier year, quoted by the learned CIT (Appeals) is enumerated below, to get the perspective of the reasoning adopted by the learned CIT (Appeals) :-

(i) The law does not provide for the deduction of liabilities which are unascertained because the actual transactions had not taken place.

(ii) Notional losses and notional income do not come within the purview of the IT Act, except when specifically provided for such as sections 115, 44AC, etc.

(iii) The reliance on the decision of Hon'ble Apex Court in the case of Woodward Governor India (P.) Ltd. (supra) is misplaced since that case concerns allowance of losses on re-statement of existing currency assets and liabilities. In the case on hand, it relates only to future sales transactions without certainty of valuation of the same. The two situations are distinguishable.

(iv) Regarding the reliance placed on AS-11 and the decision in the case of Dy. CIT (International Taxation) v. Bank of Bahrain & Kuwait [2010] 41 SOT 290 (Mum.) (SB), in that case it was held that if the quantification of the liability can be determined with reasonable accuracy, the same could be adopted. However, in the case on hand, the sale itself has not taken place and the question of any existing liability is itself uncertain.

(v) The law is reasonable in allowing the benefit of losses on actual sales arising out of exchange fluctuation. But provision for loss cannot be allowed when the actual sales had not even taken place and the maturity date of the derivative instrument has not arisen.

4.2.4 From the above findings recorded in the orders of the Assessing Officer and the learned CIT (Appeals), it appears that the Assessing Officer's view is that such a loss on foreign exchange derivatives cannot be allowed at all, as the transactions are speculative in nature and contingent in character. The stand of the learned CIT (Appeals) appears to be that such a loss can be allowed if the actual sales had taken place and the transaction is complete, but not if the transaction is to get completed on a future date.

4.3.1 Before us, the learned Authorised Representative of the assessee made elaborate oral and written submissions. The assessee submitted paper book containing the submissions made before the Assessing Officer and the learned CIT (Appeals), which were reiterated before us. The learned Authorised Representative also submitted copies of various judicial decisions in support of the assessee's contentions. The gist of the assessee's contentions are brought out in the ensuing paragraphs, as under :-

4.3.2 The assessee submits that it receives consideration in foreign exchange in respect of the services provided to the overseas customers. In order to hedge against the foreign exchange fluctuations and to limit the diminution in the value of export proceeds, the assessee has entered into forward contracts with the bankers to sell foreign currencies at a pre-determined rate. These contracts are typically spread over a period of 2 - 3 years. Due to the financial turmoil and uncertainty in the year under consideration, the Indian Rupee depreciated against the dollar thereby resulting in significant losses.

4.3.3 Such foreign exchange losses are required to be provided for and debited to the profit and loss account, as per the requirements of AS-11 dealing with "Accounting with the effects of changes in the Foreign Exchange Rates" and also the announcement of accounting for derivatives issued by the ICAI dated 29.3.2008. In accordance with the same, the assessee has provided for losses on derivative contracts and charged it off to the profit and loss account.

4.3.4 Relying on various judicial pronouncements and the principles laid down therein, the assessee submitted that the losses are allowable as business expenditure due to the following reasons :-

(i) The MTM losses are claimed as per the requirements of AS-11 and the guidelines on accounting of derivatives issued by ICAI.

(ii) It is settled principle that the accounting practice regularly followed should be taken as the basis for deciding the expenditure claim, unless it is repugnant to the provisions of the Act.

(iii) The assessee follows the mercantile system of accounting and is required to follow the procedure advised in AS-11 and there is no provision in the Act prohibiting the assessee from following the same.

(iv) The decision of the Hon'ble Apex Court in the case of Woodward Governor India (P.) Ltd. (supra) squarely applies to the assessee's case.

(v) The forward contracts are entered into on a reasonable estimate.

The learned Authorised Representative of the assessee also took us through the judicial pronouncements relied upon by him in support of the various principles put forth above.

4.4 Per contra, the learned Departmental Representative strongly supported the orders of the authorities below on this issue.

4.5.1 We have heard the rival contentions and perused and carefully considered the material on record, the submissions made and the judicial decisions placed reliance upon. It would be relevant to briefly examine the concept of "derivatives" and the underlying nature of these transactions before deciding whether they are "speculative transactions" or not; whether they represent "notional loss" or real loss and whether or not they are allowable as deduction. Simply put, a derivative is a financial instrument whose value depends on the values of the underlying exposure. The underlying exposure in the case of forex derivatives is the foreign exchange rates. The common foreign exchange derivatives are, forward contracts, option contracts and swap contracts, etc. These instruments are used to hedge the currency risk on account of adverse currency movements.

4.5.2 The term ' Marked to Market' losses (MTM) refers to losses computed as on a particular date with reference to prevailing exchange rate in respect of contracts that have not matured (i.e. open contracts). As per the prescribed Accounting Standards, companies are required to account for the MTM losses in their books of account despite the fact that the contract has not yet matured as on the Balance Sheet date.

4.5.3 Foreign Exchange Forward Contract means an agreement to exchange different currencies at a forward rate. Forward rate is the specified rate for exchange of currency at a specified future date. The assessee, in the case on hand, entered into a forward contract with the Bank to buy or sell foreign exchange at an agreed price on a future date in order to hedge against possible future financial loss due to fluctuation in the rate of foreign currency. Therefore;

(i) Firstly, the foreign exchange forward contract created a continuing, binding obligation on the date of contract against the assessee to fulfill the same on the date of maturity; and

(ii) Secondly, it is in the nature of a hedging contract because it is a contract entered into against possible future financial losses.

It follows from the above that while it is true that the assessee would come to know of the actual profit / loss only on the date of maturity, unless there is any premature cancellation of the contract, it is equally true that the assessee could anticipate the loss on the valuation date, say 31st March, with reasonable accuracy. Prudent accounting and commercial principles require that all accrued losses have to be taken into account.

4.5.4 Having considered the nature of the contract, it needs to be examined whether on account of the existing obligation arising out of the contract, a liability accrued as per the provisions of the Income Tax Act. In this regard, it is necessary to consider and take into account some of the settled principles regarding accounting propositions, which are as under :-

(i) Income is to be accounted for only when the right to receive the same has accrued in favour of the assessee, thereby creating a realisable debt in its favour; i.e. a legally enforceable right;

(ii) All anticipated losses, which accrued on the date of balance sheet have to be accounted for as per prudent accounting policies;

(iii) Stock-in-trade is valued at the end of the previous year in accordance with the matching principle in order to find out the true profit / loss.

(iv) The method of accounting consistently followed by the assessee should not be discarded casually without having good and sound reasons for the same.

4.5.5 The assessee contends that the forward contract was to be revalued in accordance with the Accounting Standards (AS) - 11 and therefore he has no option but to determine the profit / loss in regard to unmatured foreign exchange forward contracts in accordance with the currency rates as on the valuation date viz. March 31st. This contention of the assessee is not disputed. The Assessing Officer, however, is of the view that such treatment in the books of account per se did not give the assessee the right to claim the loss under the Income Tax Act. It is this contention of the Assessing Officer that requires to be examined, having regard to the fundamental commercial principles which have received judicial recognition. It is a settled principle, upheld in several decisions of the Courts, that deduction is allowable under the Act in respect of liabilities that have crystallised during the year. If an anticipated future liability is coupled with a present obligation, then that results in crystallised liability, even though the quantification may vary depending upon the terms of contract. A contingent liability depends purely on the happening or not happening of an event. Whereas, if an event has taken place, which in the case on hand was of entering into the contract and undertaking of the obligation to meet the liability, and only the consequential effect of the same is to be determined, then it cannot be said that it is in the nature of contingent liability. It is to be borne in mind that the issues relating to the accrual of income cannot be decided on the same footing and considerations on which issues relating to losses are to be decided. In the case of loss / expenditure, the concept of reasonable certainty to meet an existing obligation comes into play; which in legal terminology is referred to as "crystallisation of liability". This is in keeping and consonance with the principle of prudence as considered by the Hon'ble Apex Court in the case of Woodward Governor India (P.) Ltd. (supra). The substantial questions of law before the Hon'ble Apex Court for consideration as extracted from para 3 of its order is as under :-

"3. In this batch of civil appeals, the following question arises for determination:

(i) Whether, on the facts and circumstances of the case and in law, the additional liability arising on account of fluctuation in the rate of exchange in respect of loans taken for revenue purposes could be allowed as deduction under s. 37(1) in the year of fluctuation in the rate of exchange or whether the same could only be allowed in the year of repayment of such loans?

(ii) Whether the assessee is entitled to adjust the actual cost of imported assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance sheet date, pending actual payment of the varied liability?"

The above questions of law were elaborated by their Lordships at para 4 of the order which is extracted as under :-

"4. At the outset, for the sake of convenience, we may state that in this batch of civil appeals broadly we have before us two categories. In the first category, we are concerned with exchange differences arising in foreign currency transaction on revenue items. In such category, we are concerned with the assessee(s) incurring loss on revenue account. In that category, we are concerned with the provisions of ss. 28, 29, 37(1) and 145 of the IT Act, 1961 ("1961 Act"). In the second category of cases, we arc concerned with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets. In other words, in the second category of cases, we are concerned with the assessee(s) incurring liabilities on capital account. In such cases, we are required to consider the provisions of s. 43(1), 43A (both, before and after amendment vide Finance Act, 2002)."

4.5.6 The Hon'ble Apex Court after it considered and examined the issue, decided as at paras 13 to 21 of its order which are extracted as under :-

'13. As stated above, one of the main arguments advanced by the learned Addl. Solicitor General on behalf of the Department before us was that the word "expenditure" in s. 37(1) connotes "what is paid out" and that which has gone irretrievably. In this connection, heavy reliance was placed on the judgment of this Court in the case of Indian Molasses Company. Relying on the said judgment, it was sought to be argued that the increase in liability at any point of time prior to the date of payment cannot be said to have gone irretrievably as it can always come back. According to the learned counsel, in the case of increase in liability due to foreign exchange fluctuations, if there is a revaluation of the rupee vis-a-vis foreign exchange at or prior to the point of payment, then there would be no question of money having gone irretrievably and consequently, the requirement of "expenditure" is not met. Consequently, the additional liability arising on account of fluctuation in the rate of foreign exchange was merely a contingent/notional liability which does not crystallize till payment. In that case, the Supreme Court was considering the meaning of the expression "expenditure incurred" while dealing with the question as to whether there was a distinction between the actual liability in praesenti and a liability de futuro. The word "expenditure" is not defined in the 1961 Act. The word "expenditure" is, therefore, required to be understood in the context in which it is used. Sec. 37 enjoins that any expenditure not being expenditure of the nature described in ss. 30 to 36 laid out or expended wholly and exclusively for the purposes of the business should be allowed in computing the income chargeable under the head "Profits and gains of business". In ss. 30 to 36, the expressions "expenses incurred" as well as "allowances and depreciation" has also been used. For example, depreciation and allowances are dealt with in s. 32. Therefore, Parliament has used the expression "any expenditure" in s. 37 to cover both. Therefore, the expression "expenditure" as used in s. 37 may, in the circumstances of a particular case, cover an amount which is really a "loss" even though the said amount has not gone out from the pocket of the assessee.

14. In the case of M.P. Financial Corporation v. CIT [1986] 51 CTR (MP) 249 : (1987) 165 ITR 765 (MP) the Madhya Pradesh High Court has held that the expression "expenditure" as used in s. 37 may, in the circumstances of a particular case, cover an amount which is a "loss" even though the said amount has not gone out from the pocket of the assessee. This view of the Madhya Pradesh High Court has been approved by this Court in the case of Madras Industrial Investment Corpn. Ltd. v. CIT [1997] 139 CTR (SC) 555 : (1997) 225 ITR 802 (SC). According to the Law and Practice of Income-tax by Kanga and Palkhivala, s. 37(1) is a residuary section extending the allowance to items of business expenditure not covered by ss. 30 to 36. This section, according to the learned author, covers cases of business expenditure only, and not of business losses which are, however, deductible on ordinary principles of commercial accounting. It is this principle which attracts the provisions of s. 145. That section recognizes the rights of a trader to adopt either the cash system or the mercantile system of accounting. The quantum of allowances permitted to be deducted under diverse heads under ss. 30 to 43C from the income, profits and gains of a business would differ according to the system adopted. This is made clear by defining the word "paid" in s. 43(2), which is used in several ss. 30 to 43C, as meaning actually paid or incurred according to the method of accounting upon the basis on which profits or gains are computed under s. 28/29. That is why in deciding the question as to whether the word "expenditure" in s. 37(1) includes the word "loss" one has to read s. 37(1) with s. 28, s. 29 and s. 145(1). One more principle needs to be kept in mind. Accounts regularly maintained in the course of business are to be taken as correct unless there are strong and sufficient reasons to indicate that they are unreliable. One more aspect needs to be highlighted. Under s. 28(i), one needs to decide the profits and gains of any business which is carried on by the assessee during the previous year. Therefore, one has to take into account stock-in-trade for determination of profits. The 1961 Act makes no provision with regard to valuation of stock. But the ordinary principle of commercial accounting requires that in the P&L a/c the value of the stock-in-trade at the beginning and at the end of the year should be entered at cost or market price, whichever is the lower. This is how business profits arising during the year needs to be computed. This is one more reason for reading s. 37(1) with s. 145. For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant. This is because profits/loss is embedded in the closing stock. While anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as no prudent trader would care to show increase profits before actual realization. This is the theory underlying the rule that closing stock is to be valued at cost or market price, whichever is the lower. As profits for income-tax purposes are to be computed in accordance with ordinary principles of commercial accounting, unless, such principles stand superseded or modified by legislative enactments, unrealized profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the following years account in a continuing business are not brought to the charge as a matter of practice, though, as stated above, loss due to fall in the price below cost is allowed even though such loss has not been realized actually. At this stage, we need to emphasise once again that the above system of commercial accounting can be superseded or modified by legislative enactment. This is where s. 145(2) comes into play. Under that section, the Central Government is empowered to notify from time to time the Accounting Standards to be followed by any class of assessees or in respect of any class of income. Accordingly, under s. 209 of the Companies Act, mercantile system of accounting is made mandatory for companies. In other words, Accounting Standard which is continuously adopted by an assessee can be superseded or modified by legislative intervention. However, but for such intervention or in cases falling under s. 145(3), the method of accounting undertaken by the assessee continuously is supreme. In the present batch of cases, there is no finding given by the AO on the correctness or completeness of the accounts of the assessee. Equally, there is no finding given by the AO stating that the assessee has not complied with the Accounting Standards.

15. For the reasons given hereinabove, we hold that, in the present case, the "loss" suffered by the assessee on account of the exchange difference as on the date of the balance sheet is an item of expenditure under s. 37(1) of the 1961 Act.

16. In the light of what is stated hereinabove, it is clear that profits and gains of the previous year are required to be computed in accordance with the relevant Accounting Standard. It is important to bear in mind that the basis on which stock-in-trade is valued is part of the method of accounting. It is well established, that, on general principles of commercial accounting, in the P&L account, the values of the stock-in-trade at the beginning and at the end of the accounting year should be entered at cost or market value, whichever is lower-the market value being ascertained as on the last date of the accounting year and not as on any intermediate date between the commencement and the closing of the year, failing which it would not be possible to ascertain the true and correct state of affairs. No gain or profit can arise until a balance is struck between the cost of acquisition and the proceeds of sale. The word "profit" implies a comparison between the state of business at two specific dates, usually separated by an interval of twelve months. Stock-in-trade is an asset. It is a trading asset. Therefore, the concept of profit and gains made by business during the year can only materialize when a comparison of the assets of the business at two different dates is taken into account. Sec. 145(1) enacts that for the purpose of s. 28 and s. 56 alone, income, profits and gains must be computed in accordance with the method of accounting regularly employed by the assessee. In this case, we are concerned with s. 28. Therefore, s. 145(1) is attracted to the facts of the present case. Under the mercantile system of accounting, what is due is brought into credit before it is actually received; it brings into debit an expenditure for which a legal liability has been incurred before it is actually disbursed. (judgment of this Court in the case of United Commercial Bank v. CIT [1999] 156 CTR (SC) 380 : (1999) 240 ITR 355 (SC)). Therefore, the accounting method followed by an assessee continuously for a given period of time needs to be presumed to be correct till the AO comes to the conclusion for reasons to be given that the system does not reflect true and correct profits. As stated, there is no finding given by the AO on the correctness of the Accounting Standard followed by the assessee(s) in this batch of civil appeals.

17. Having come to the conclusion that valuation is a part of the accounting system and having come to the conclusion that business losses are deductible under s. 37(1) on the basis of ordinary principles of commercial accounting and having come to the conclusion that the Central Government has made Accounting Standard-II mandatory, we are now required to examine the said Accounting Standard ("AS").

18. AS-11 deals with giving of accounting treatment for the effects of changes in foreign exchange rates. AS-11 deals with effects of exchange differences. Under para 2, reporting currency is defined to mean the currency used in presenting the financial statements. Similarly, the words "monetary items" are defined to mean money held and assets and liabilities to be received or paid in fixed amounts, e.g., cash, receivables and payables. The word "paid" is defined under s. 43(2). This has been discussed earlier. Similarly, 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 all monetary items which have to be valued at the closing rate under AS-11. Under para 5, a transaction in a foreign currency has to be recorded in the reporting currency by applying to the 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-11 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 date monetary items, enumerated above, denominated in a foreign currency should be reported using the closing rate. In case of revenue items falling under s. 37(1), para 9 of AS-11 which deals with recognition of exchange differences, needs to be considered. Under that para, exchange differences arising on foreign currency transactions have to be recognized as income or as 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 s. 43A of the 1961 Act. At this stage, we are concerned only with para 9 which deals with revenue items. Para 9 of AS-11 recognises exchange differences as income or expense. In cases where, e.g., the rate of dollar rises vis-a-vis the Indian rupee, there is an expense during that period. 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 P&L account for the reporting period.

19. A company imports raw material worth US $ 250000 on 15th Jan., 2002 when the exchange rate was Rs. 46 per US $. The company records the transaction at that rate. The payment for the imports is made on 15th April, 2002 when the exchange rate is Rs. 49 per US $. However, on the balance sheet date, 31st March, 2002, the rate of exchange is Rs. 50 per US $. In such a case, in terms of AS-11, the effect of the exchange difference has to be taken into P&L account. Sundry creditors is a monetary item and hence such item has to be valued at the closing rate, i.e. Rs. 50 at 31st March, 2002, irrespective of the payment for the sale subsequently at a lower rate. The difference of Rs. 4 (50-46) per US $ is to be shown as an exchange loss in the P&L account and is not to be adjusted against the cost of raw materials.

20. In the case of Sutlej Cotton Mills Ltd. v. CIT [1978] CTR (SC) 155 (1979) 116 ITR 1 (SC) this Court has observed as under:

"The law may, therefore, now be taken to be well settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be a trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as a part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature."

21. In conclusion, we may state that in order to find out if an expenditure is deductible the following have to be taken into account (i) whether the system of accounting followed by the assessee is mercantile system, which brings into debit the expenditure amount for which a legal liability has been incurred before it is actually disbursed and brings into credit what is due, immediately it becomes due and before it is actually received; (ii) whether the same system is followed by the assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue to it; (iv) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains; (v) whether the method adopted by the assessee for making entries in the books both in respect of losses and gains is as per nationally accepted Accounting Standards; (vi) whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reducing the incidence of taxation.'

4.5.7 As can be seen from the extractions reproduced above, the decision in the case of Woodward Governor India (P.) Ltd. (supra) has been rendered in respect of "monetary items", denominated in foreign currency which include to mean money held and assets and liabilities to be received or paid in fixed amounts, e.g. cash, foreign currency notes, balance in bank accounts denominated in a foreign currency, receivables / payables and loans denominated in a foreign currency, sundry creditors, etc. are all monetary items. The decision is also related to transactions in which a legal liability has been incurred before it is actually disbursed. We are therefore unable to concur or agree with the view of the learned CIT (Appeals), that liability could arise only when the contract would have matured, as such a stand is totally divorced from the accounting principles and is in variance with the principle upheld by the Hon'ble Apex Court in the case of Woodward Governor India (P.) Ltd. (supra). It can also be seen that the decision in the case of Woodward Governor India (P.) Ltd. (supra) (as extracted above) has been rendered with regard to items in the revenue account and capital account. Therefore, the view of the learned CIT (Appeals) that this decision of the Hon'ble Apex Court relates to only restatement of existing currency liabilities and assets is not correct.

4.5.8 In the case on hand, it is not in dispute that the forward contracts have been entered into by the assessee in order to protect its interest against fluctuations in foreign currency, in respect of consideration for export proceeds, which is a revenue item. Therefore, in sum and substance, it has the trappings of stock-in-trade and the assessee has to restate or revalue the same as on the Balance Sheet date. The consequent effect of this accounting treatment was to recognize the exchange fluctuation gain or loss in the profit and loss account as on the valuation date. In view of the facts and circumstances of the case as discussed above, we are of the considered view that the appeal of the assessee on this issue, succeeds for the following reasons :-

(i) A binding obligation accrued against the assessee when it entered into foreign exchange forward contracts;

(ii) The forward contracts are in respect of consideration for export proceeds, which are revenue items;

(iii) The liability is determinable with reasonable certainty when an obligation is pending on the balance sheet date and such a liability cannot be said to be a contingent liability.

(iv) The accounting treatment is as per Accounting Standards and the ICAI Guidelines.

(v) The principles enunciated by the Hon'ble Apex Court in the case of Woodward Governor India (P.) Ltd. (supra) are applicable to the facts of the case on hand.

4.5.9 We had earlier observed that the Assessing Officer had relied on the CBDTs Instruction No.3/2010. Paras 1 and 3 of this Instruction reads as under :-

"1.Foreign Exchange derivative transactions entered into by the corporate sector in India have witnessed a substantial growth in recent years. This combined with extreme volatility in the foreign exchange market in the last financial year is reported to have resulted in substantial losses to an assessee on account of trading in forex-derivatives. A large number of assesses are said to be reporting such losses on 'marked to market' basis either suo motu or in compliance of the Accounting Standard or advisory circular issued by the Institute of Chartered Accountants. The issue whether such losses on account of forex-derivatives can be allowed against the taxable income of an assessee has been considered by the Board. In this connection, I am directed to say that the Assessing Officers may follow the guidelines given below:

2.......

3. Treatment of loss from actual transactions in forex-derivatives. In a case where a loss on a forex-derivative transaction arises on actual settlement / conclusion of contract and is not a notional or marked to market book entry, a further question will arise as to whether such a loss is on account of a speculative transaction as contemplated in Section 43(5) of the Income tax Act. For determining whether loss from a transaction in respect of a forex-derivative is a speculation loss or not, the Assessing Officers may refer to Proviso (d) below sub-section (5) of Section 43 inserted by the Finance Act, 2005, with effect from 1.4.2006. It lays down that any 'eligible transaction' in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956, that has been carried out in a recognized stock exchange shall not be treated as a speculative transaction. Further, an 'eligible transaction' for this purpose would be one that fulfils the conditions laid down in Explanation to Section 43(5)(d). Any loss in a speculative transaction can be set off only against profit from speculative transactions.

In the case on hand, as discussed earlier, a contract has been concluded and a liability has crystallized. In this factual matrix, from the wordings of the Instruction, it follows that the loss arising out of the forward contract is not notional. In such a case, the CBDT Instruction requires the Assessing Officer to examine whether such a loss is on account of a speculative transaction as contemplated in section 43(5) of the Act."

4.5.10 The issue of speculative transactions and hedging transactions has been examined and analysed in detail in the decision of the ITAT, Mumbai in the case of S. Vinodkumar Diamonds (P) Ltd. v. Addl. CIT [2013] 35 taxmann.com 337/59 SOT 124. The relevant paragraphs of this order are extracted hereunder and read as follows :

" 5.2.1. The definition of 'speculative transaction' in section 43(5) of the Act, gives a simple test for deciding for the purpose of income-tax what a speculative transaction means. If a contract for sale or purchase is ultimately settled and no actual delivery of the goods was effected under the settlement then it is a speculative transaction. The requirement of section 30 of the Indian Contract Act of the existence of the intention of the parties even at the time of the original contract not to give or take delivery of the goods in order to make it a speculative/wagering transaction is dispensed with for the purpose of the Act and if actual delivery is not given/taken under the settlement of contract, then the intention of the parties at the time of the contract becomes im-material. Thus, the true test is delivery of commodities/goods as per the contract, including a forwarding contract. Profit/loss in respect of unperformed contracts is considered speculation profit/loss. In short, in order that a transaction may fall within the scope of the expression 'speculative transaction', it must be a transaction in which a contract for purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips.

5.2.2. Here, it would be useful to appreciate in proper perspective how hedge transactions are commercially understood before determining the true scope, width and nature of proviso (a) to section43(5). Hedge contracts are those contracts which hedge against prejudicial price fluctuations. In speculative transactions the modus operandi of persons indulging in them is that when one enters into a contract of purchase, he also simultaneously enters into one or more contracts of sale against the same quantity deliverable at the same time either to the original vendor or to someone else, so as either to secure profit or to minimize loss, before the Vaida day ; and similarly when he enters into a contract of sale, he simultaneously enters into one or more contracts to purchase the same quantity before the Vaida day. The result of such dealings, when the sale and purchase are to and from the same person, has the effect of cancelling the contracts leaving only differences to be paid. The technique of hedge trading can be understood in simple terms. It is said that the hedge contract is so called because it enables the persons dealing with the actual commodity to hedge themselves, i.e., to insure themselves against adverse price fluctuations. A dealer or a merchant enters into a hedge contract when he sells or purchases a commodity in the forward market for delivery at a future date. His transaction in the forward market may correspond to a previous purchase or sale in the ready market or he may propose to cover it later by a corresponding transaction in the ready market, or he may offset it by a reverse transaction on the forward market itself. Hedging contracts need not succeed the contracts for sale and actual delivery of goods manufactured, but the latter may be subsequently entered into, provided they are within reasonable time. In order to be genuine and valid hedging contracts of sales, the total of such transactions should not exceed the total stocks of the raw materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of purchase. As per the accepted commercial norms object of a hedging contract is to secure oneself against loss in a future delivery contract, but such transactions cannot be regarded as inter-connected. Each one is independent of the other. So far as the profit or loss arising from a future delivery contract is concerned, it is determined on the date of actual delivery irrespective of the date on which the contract was entered into. In respect of a hedging contract, profit/loss arising there from can be ascertained or crystallised at fixed intervals of the term when the clearance takes place.

5.2.2.a. By resorting to counterbalancing transactions in the market for the ready commodity on the one hand and in the hedge market on the other hand, the hedger seeks to safeguard his position. The movement of prices in the two markets may not always follow an identical course and the hedger might at times gain and at times lose but such a gain or loss would be marginal and far less than what it would be if the person had not hedged at all. While, however, the hedging operation protects the hedger against loss arising from adverse fluctuations in prices, it also prevents him from making windfall profit owing to favourable fluctuations in prices as well. The forgoing of such a possible windfall profit is the price which he pays for the insurance against loss. This well-known technique, of hedge trading clearly implies forward contracts both ways, namely, for sale and purchase with a view to guarding against adverse price fluctuations. These forward contracts by way of hedge transactions usually afford a cover to a trader inasmuch as his loss in the ready market is offset by a profit in the forward market and vice versa. It, therefore, follows that in order to effectively hedge against adverse price fluctuations of the manufactured goods or merchandise, a manufacturer or merchant has necessarily to enter into forward transactions of sale and purchase both, and without these contracts of sale and purchase constituting hedge transactions, there would be no effective insurance against the risk of loss in the price fluctuations of the commodity, manufactured or the merchandise sold.

5.3. Hedging contracts are dealt in Clause (a) of the proviso to section 43(5) of the Act. From the above discussion it can safely stated that the said clause applies, if following conditions are fulfilled:

(1) There is a contract for actual delivery of goods manufactured by the assessee /a merchandise sold by it,

(2) Assessee must be a subsequent transaction intend to guard against losses through future price fluctuations in respect of such contract,

(3) Transaction in question must be a contract entered into in respect of raw materials or merchandise in the course of the assessee's manufacturing business and it should have been settled otherwise than by actual delivery of goods,

(4) Hedging contracts may be both with regard to sales and purchases,

(5) Hedging contracts need not succeed the contracts for sale and actual delivery of goods manufactured, but the latter may be subsequently entered into, provided they are within the reasonable time not exceeding generally the assessment year,

(6) In order to be genuine and valid hedging contracts of sales, the total of such transactions should not exceed the total stocks of the raw materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of purchases,

(7) The hedging contract need not necessarily be in the same variety of the commodity they could be in connected commodities, e.g., one type of cotton against another type of cotton. In other words unless the assessee shows that there was some existing contract in respect of which he was likely to suffer a loss because of future price fluctuations and that it was to safeguard against such loss that he entered into the forward contracts of sale, he could not claim the benefit of clause (a) of the proviso to section 43(5). With regard to speculative / hedging transactions we had benefit of perusing the judgments of M.G.Bros. v. CIT [1985] 154 ITR 695/20 Taxman 90 (AP), Nuddea Mills Co. Ltd. v. CIT [1988] 171 ITR 169/[1987] 35 Taxman 3 (Cal.), Delhi Flour Mills Co. Ltd. v CIT [1974] 95 ITR 151 (Delhi) and Pankaj Oil Mills v CIT [1978] 115 ITR 824 (Guj.) delivered by the Hon'ble High Courts of Andhra Pradesh, Calcutta, Delhi and Gujarat respectively."

4.5.11 As discussed earlier, in the case on hand there has been an existing contract with a binding obligation accrued against the assessee when it entered into for-ex forward contracts. The forward contracts are in respect of consideration for exports proceeds, which are revenue items. There is an actual contract for sale of merchandise. In this factual matrix, it is clear in our view that the transaction in question will not qualify to be called as speculative transaction. In view of the facts and circumstances of the case on hand, as discussed above, we hold that the provision for losses on derivative contracts is allowable as expenditure. We, accordingly allow the Grounds at S.Nos.1 to 9 raised by the assessee.

5. Ground Nos. 10 to14 : Disallowance u/s.14A of the Act.

5.1 In the course of assessment proceedings, the Assessing Officer noticed that the assessee had total investments amounting to Rs.2018.07 lakhs as on 31.3.2009, out of which Rs.1900.45 lakhs was investment in equity shares. The assessee submitted that it had not earned any exempt income in the form of dividends from these investments during the year under consideration and therefore the provisions of section 14A of the Act are not applicable. The Assessing Officer, however, did not accept the above submissions of the assessee and held that the provisions of section 14A r.w. Rule 8D of the I.T. Rules, 1962 mandates that the Assessing Officer determines the expenditure incurred in relation to income which does not form part of the total income. In coming to this view, the Assessing Officer placed reliance on the decision of the Special Bench of the Mumbai ITAT in the case of Cheminvest Ltd. v ITO [2009] 121 ITD 318. Invoking the provisions of section 14A r.w. Rule 8D(2)(iii), the Assessing Officer determined the expenditure incurred at Rs.7,34,975 and disallowed the same.

5.2 On appeal, the learned CIT (Appeals) upheld the decision of the Assessing Officer in making the disallowance of Rs.7,34,975 u/s.14A r.w. Rule 8D, citing the decision in the case of Cheminvest Ltd. (supra) relied on by the Assessing Officer, quoting therefrom and also noting that the view taken therein has been supported by the decision of the ITAT, Delhi in the case of Technopak Advisors (P.) Ltd. v Addl. CIT [2012] 50 SOT 31.

5.3 In appellate proceedings before us, the learned A.R. of the assessee reiterated the submissions of the assessee made before the authorities below, that these investments have been made in the Group Companies and have not been made with the intention to earn income and that no income has been earned by the assessee on these investments during the year under consideration. Since no exempt income has been earned during the year the question of making any disallowance of any expenditure does not arise. In support of the aforesaid contentions, the learned Authorised Representative relied on several judicial decisions, including the following decisions of the Hon'ble High Courts :-

(i) CIT v Corrtech Energy (P.) Ltd. [2014] 223 Taxman 130/45 taxmann.com 116 (Guj.).

(ii) CIT v Shivam Motors (P.) Ltd. [IT Appeal No.88 of 2014 dated 5.5.2014]

5.4. Per contra, the learned Departmental Representative strongly supported the impugned order of the learned CIT (Appeals).

5.5.1 We have heard the rival contentions and perused and carefully considered the material on record, including the various judicial decisions cited and placed reliance upon. As pointed out by both the Assessing Officer and the learned CIT (Appeals), the Special Bench of the Mumbai Tribunal in the case of Cheminvest Ltd. (supra) has held that the disallowance for expenditure incurred could be made even in the year in which exempt income has not been earned. In our considered view, this decision of the Special Bench of the Mumbai Tribunal has been impliedly overturned by several judgments in various cases by several High Courts; as will be brought out in the succeeding paragraphs of this order.

5.5.2 In the case of Shivam Motors (P.) Ltd. (supra), the Hon'ble Allahabad High Court, inter alia, considered the following substantial question of law :-

"2. Whether on the facts and in the circumstances of the case and in law, the Income Tax Appellate Tribunal was justifie

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d in upholding the decision of CIT (Appeals) in deleting the disallowance of Rs.2,03,752 u/s. 14A ignoring the fact that there is difference of opinion of various courts on the view taken by the ITAT that in the absence of tax free income, no disallowance u/s. 14A is permissible." The Hon'ble High Court has answered the above question of law as under :- "As regards the second question, section 14A of the Act provides that for the purposes of computing the total income under the Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act. Hence, what section 14A provides is that if there is any income which does not form part of the income under the Act, the expenditure which is incurred for earning the income is not an allowable deduction. For the year in question, the finding of fact is that the assessee had not earned any tax free income. Hence, in the absence of any tax free income, the corresponding expenditure could not be worked out for disallowance. The view of the CIT (Appeals), which has been affirmed by the Tribunal, hence does not give rise to any substantial question of law. Hence, the deletion of the disallowance of Rs.2,03,752 made by the Assessing Officer was in order." 5.5.3 The Hon'ble Gujarat High Court in the case of Corrtech Energy (P.) Ltd. (supra) has adjudicated on this issue at para 3.2 thereof as under :- "3.2..... We have given our thoughtful consideration to the facts and the decision relied upon by the ld.AR. The Hon'ble Punjab & Haryana High Court in the case of CIT v. Winsome Textile Industries Ltd. [2009] 319 ITR 204 (Punj. & Har.) has held that in the present case, admittedly, the assessee did not make any claim for exemption. In such a situation, section 14A could have no application. In this case also, the assessee has not claimed any exempt income in this year. Therefore, respectfully following the judgment of Hon'ble High Court of Punjab & Haryana in the case of CIT v. Winsome Textile Industries Ltd. (supra), we hereby allow this ground and direct the A.O. to delete the addition. Therefore, ground NOs.1 to 1.2 raised by the assessee in its cross-objection are to be allowed." 5.5.4 There are many other decisions of other Hon'ble High Courts as well, wherein it has been held that where the assessee has not earned any income exempt u/s. 10(38) of the Act, disallowance of expenditure u/s. 14A of the Act is not tenable. Respectfully following the above decisions (cited supra), we also hold that the disallowance of expenditure u/s. 14A of the Act is not tenable and therefore delete the disallowance of Rs.7,34,975 made by the Assessing Officer. 6.1 In the grounds at S.Nos.15 & 16, the assessee has also raised the contention that the Assessing Officer erred in recomputing the MAT Credit u/s.115JAA of the Act by considering the enhanced income on account of the disallowance made in the order of assessment for Assessment Year 2008-09. 6.2 We have heard both parties on the issue and considered the material on record. It is settled principle that the provisions of section 115 of the Act is a separate code in itself and that the 'book profits' have to be computed as provided under that section. If the disallowances made are not as per the provisions of that section, then those cannot be considered in computing the book profits. The Assessing Officer is directed to examine and verify the disallowances made while computing the 'book profits' and allow credit in accordance with law. The grounds raised by the assessee at S.Nos.15 and 16 are disposed off as indicated above. 7. Additional Grounds raised by the assessee. 7.1 In view of our decision rendered in the substantive grounds of appeal at S.Nos. 1 to 9, the additional grounds raised by the assessee at S.Nos.19 & 20 (supra) require no adjudication. 8. In the grounds at S.No.17, the assessee denies itself liable to be charged interest under section 234B of the Act. The charging of interest is consequential and mandatory and the Assessing Officer has no discretion in the matter and we therefore uphold his action of charging the said interest. The charging of interest has been upheld by the Hon'ble Apex Court in the case of CIT v. Anjum M.H. Ghaswala [2001] 252 ITR 1/119 Taxman 352 The Assessing Officer is, however, directed to recompute the interest chargeable under section 234B of the Act, if any, while giving effect to this order. 9. In the ground raised at S.No.18, the assessee has challenged the order of the learned CIT (Appeals) in dismissing its appeal on the issue of the Assessing Officer initiating penalty proceedings by issue of notice under section 274 r.w.s. 271 of the Act. As observed by the learned CIT (Appeals), at the stage of initiation of penalty proceedings by the Assessing Officer, no cause of grievance arises to the assessee, since there is no penalty levied. We are of the view that this ground is premature and not maintainable and is therefore dismissed. 10. In the result, the assessee's appeal for Assessment Year 2009-10 is partly allowed as indicated above. ITA No.275/Bang/2014 - Revenue's appeal for Assessment Year 2009-10. 11. The grounds at S.Nos.1, 4 & 5 raised by revenue being general in nature, no adjudication is called for thereon. 12.1 In the grounds raised at S.Nos.2 and 3, revenue has assailed the decision of the learned CIT (Appeals) to allow the loss on speculation actually incurred by the assessee. It is revenue's contention that the transaction in question is speculative in nature in terms of CBDT's Instruction NO.3/2010 and hence section 73 of the Act which does not allow the setting off of the speculation loss against the income of the current year and the speculation loss can be allowed to be carried forward and set off against the speculation income in future years. 12.2 We have considered the submissions of Revenue. As we have already held earlier in this order, that the scope of CBDT's Instruction No.3/2010 does not cover the transaction in question and that the transaction in question is not speculative in nature, the above contentions raised by revenue is not tenable and we therefore dismiss the grounds at S.Nos.2 and 3 raised by revenue. 13. In the result, revenue's appeal for Assessment Year 2009-10 is dismissed.
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