ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur IN INCOME TAX APPELLATE TRIBUNAL, VISAKHAPATNAM BENCH, VISAKHAPATNAM BEFORE SHRI V. DURGA RAO, JUDICIAL MEMBER & SHRI G. MANJUNATHA, ACCOUNTANT MEMBER I.T.A.No.487/Vizag/2012 ( Assessment Year: 2009-10) ACIT, Circle-1, Sri Ramalingeswara Rice & Oil Mill, Rajahmundry Vs. Velpur PAN: AAIFS3902M] ( Appellant) (Respondent) Appellant by : Shri Aravindakshan, DR Respondent by : Shri G.V.N. Hari, AR Date of hearing : 08.09.2016 Date of Pronouncement : 07.10.2016 O R D E R PER G. MANJUNATHA, Accountant Member: This appeal filed by revenue is directed against order of CIT(A), Guntur, dated 3.10.2012 and it pertains to assessment year 2009-10. 1 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur 2. brief facts of case are that assessee is partnership firm carrying on business of rice mill and forward contracts, filed its return of income for assessment year 2009-10 on 29.9.2010 declaring loss of ` 2,51,48,852/-. case has been selected for scrutiny through CASS, and accordingly, notice u/s 143(2) & 142(1) of Income Tax Act, 1961 (hereinafter called as 'the Act') were issued. In response to notices, authorized representative of assessee appeared from time to time and furnished details and other information called for. During course of assessment proceedings, A.O. observed that in this case, survey operation u/s 133A of Act was conducted on 16.11.2010. During course of survey operation, books of accounts, registers and documents have been found and impounded. impounded books of accounts reveals that assessee is maintaining gate passes for inward of materials purchased and on verification of gate passes maintained by assessee, it was noticed that assessee is not maintaining serial number, name of farmer from whom paddy was purchased, village, details of goods purchased, weight in quintals, mode of transport/vehicle numbers, date of purchase and signature of receiving person. Since books of accounts maintained by assessee are found with discrepancies, A.O. opined that purchases shown in books of accounts are not 2 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur correct. Keeping these facts into consideration, disallowed 5% of paddy purchases which works out to ` 1,19,53,700/-. Similarly, A.O. observed that assessee has claimed various expenditures, however, failed to file bills and vouchers and other relevant details in support of expenditure claimed, therefore, disallowed 10% expenditures under head freight charges, travelling & conveyance expenses, administrative expenses, vehicle maintenance expenses, repairs & maintenance, processing & packing, printing & stationery and added back to total income. 3. A.O. further observed that, during year, assessee firm is engaged in business of export of Agri commodities. After procurement of export order from prospective buyers at fixed rate, firm will procure goods locally and shipment of goods will be dispatched to foreign countries. In its business of export of agri commodities, assessee firm used to enter into forward contracts with their bankers to hedge currency risk to mitigate possible fluctuation in currency. During year, assessee firm has entered into forward exchange contracts with its banker. A.O. observed that assessee has entered into forward exchange contract without there being any exports turnover to hedge possible loss in foreign 3 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur currency. A.O. further observed that assessee has entered into forward contracts to deal in currency, therefore, opined that forward contract entered by assessee are in nature of speculative transactions. Therefore, issued show cause notice and asked to explain why loss incurred under head Exchange loss shall not be disallowed. 4. In response to show cause notice, assessee submitted that it is in business of export of agri-commodities and in process, it has entered into forward exchange contracts to hedge fluctuation in foreign currency. assessee firm entered into forward contracts with their bankers to mitigate future losses in fluctuation in foreign currency. assessee further submitted that firm has done export turnover of more than ` 80 crores in preceding financial year, however, during current financial year, its export turnover became nil because of unexpected ban imposed by Government of India on export of rice. assessee further submitted that Government of India has imposed ban on export of rice in beginning of financial year for period of 3 months, however, it has been further extended to whole financial year. assessee was on bonafide belief that ban imposed by Government on export of rice is temporary, once 4 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur ban is lifted, firm can resume its operations and continue its exports. assessee further submitted that it has entered into forward exchange contracts in previous financial years and same were continued during current financial year. Since there was no export turnover, it has closed forward exchange contracts with its bankers and resultant loss on account of fluctuation in foreign currency has been recognized as business loss, therefore, it cannot be held as speculative transaction. 5. A.O. after considering explanations of assessee, held that expenditure claimed by assessee under head exchange loss is not allowable as business expenditure, as it is only notional loss, but not crystalised loss. A.O. further observed that assessee has entered into forward exchange contracts without there being any underlying exposure i.e. export turnover, therefore, loss incurred by assessee is speculative loss which cannot be allowed as normal business loss. A.O. has discussed at length term speculative loss, derivatives and forward exchange contracts and came to conclusion that loss against currency fluctuations, crystallization of liability will not be there. A.O. further observed that assessee has failed to correlate hedging of foreign currency with 5 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur necessary expenditures on merchandise for sale i.e. export obligation. In absence of such export obligation, it can be inferred that hedging of profits by way of forward contracts is not related to business activity of assessee. Though assessee claims that it had export turnover in immediately preceding financial year, during current financial year, it has achieved zero export turnover. explanation of assessee that ban on export of rice is temporary, it can continue its export once ban is lifted cannot be accepted, as facts remains that assessee could not do any exports and also it has purchased forward contracts even after ban was imposed by Government. Therefore, it cannot be held that assessee has entered into forward exchange contracts to hedge possible loss in currency fluctuations. With these observations, disallowed loss claimed by assessee and added back to total income. 6. Aggrieved by assessment order, assessee preferred appeal before CIT(A). Before CIT(A), assessee reiterated submissions made before A.O. CIT(A) after considering explanations of assessee, partly allowed appeal filed by assessee. CIT(A) deleted additions made towards disallowance of 5% paddy purchases, by holding that documentary evidences produced 6 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur in support of paddy purchases shows that there was no inflation of purchase of paddy or suppression of quantity of paddy purchases during year under report. As sought to be highlighted by assessee, no defects in books were pointed out by A.O. nor did same stand rejected. Further, no defects in form B register were mentioned and no points were raised on purchase price paid by appellant. only defect pointed out by A.O. is irregular maintenance of gate passes. During course of appellate proceedings, assessee has filed copy of order of Government announcing Minimum Support Price (MSP) of paddy and also order passed by agricultural marketing committee, wherein quantity recorded by assessee in its books of accounts and quantity assessed by authority are one and same. As regards disallowance of travelling & conveyance expenses, administrative expenses and vehicle maintenance, CIT(A) has sustained additions to extent of ` 2 lakhs and balance is directed to be deleted. As regards disallowance of repairs & maintenance, processing expenses and printing & stationery, sustained additions of ` 4,50,000/- and balance amount is directed to be deleted. With regard to disallowance of loss on forward contracts, CIT(A) held that loss claimed by assessee is not notional loss and loss is incurred on termination/renewal of forward exchange 7 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur contracts. A.O. disallowed loss on ground that loss claimed by assessee is marked to market losses (MTM), however, on perusal of details filed by assessee, it was observed that losses have been debited by bankers on termination of forward contracts, therefore, A.O. was not correct in disallowing loss incurred by assessee. Aggrieved by CIT(A) order, revenue is in appeal before us. 7. first issue that came up for our consideration is disallowance of 5% paddy purchases. A.O. disallowed 5% paddy purchases for reasons that gate passes maintained by assessee are not giving true and correct position of purchases. A.O. was of opinion that during course of survey operation, impounded documents reveals that assessee is not maintaining proper gate passes for recording purchases of paddy. According to A.O., assessee is not mentioning serial number and other details in gate passes, therefore, opined that assessee has inflated paddy purchases. It is contention of assessee that its paddy purchases are supported by valid bills & vouchers and also it has paid agricultural marketing cess, according to which there is no difference in paddy purchases recorded in its books of accounts and order passed by agricultural marketing 8 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur committee. We find force in arguments of assessee for reason that during course of appellate proceedings, assessee has furnished copy of order passed by agricultural marketing committee and reconciled quantity of paddy purchases with MSP to its books of accounts. CIT(A) has recorded categorical finding of facts that purchases recorded by assessee and purchases as per AMC reports are matched. revenue failed to prove finding of facts recorded by CIT(A) is incorrect. Therefore, we are of view that CIT(A) has rightly deleted additions made towards disallowance of paddy purchases. We do not see any error or infirmity in order of CIT(A). Hence, we inclined to upheld CIT(A) order and reject ground raised by revenue. 8. next issue that came up for our consideration is disallowance of certain expenditure on adhoc basis. A.O. disallowed adhoc disallowance of 10% expenditure under head freight charges, travelling and conveyance, administrative expenses, vehicle maintenance, repairs & maintenance expenditure, processing & packing and printing & stationery. A.O. disallowed expenditure on ground that assessee has failed to substantiate expenses with necessary bills & vouchers. A.O. observed that assessee has 9 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur maintained self-made vouchers and vouchers maintained by assessee are not having serial numbers, signature of managing partner and no revenue stamps are affixed and in few vouchers, recipient signature is not obtained, therefore, opined that vouchers maintained by assessee are not susceptible for verification. It is contention of assessee that it has maintained proper bills & vouchers in support of all expenses. assessee further submitted that due to huge volume of transactions, cashier has been preparing single vouchers when nature of payment comes under same head by taking entire recipients signature on same vouchers. As regards not affixing revenue stamp on vouchers, it was submitted that due to non-availability of revenue stamp, firm had not been affixed revenue stamp on vouchers. assessee further submitted that considering its total volume of businesses, expenditure claimed under head freight charges and other expenses is meager in nature and also all expenditures are covered by fringe benefit tax, therefore, there was no reason for A.O. to doubt genuineness of expenditure. We find force in arguments of assessee for reason that considering huge volume of business of assessee, expenditure incurred by assessee under freight charges and other expenditure is meager in nature. We further observed that all 10 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur expenditure is covered under fringe benefit tax. A.O., while assessing fringe benefit tax has accepted expenditure claimed by assessee as genuine in nature. Therefore, we are of view that once expenditure has been accepted as genuine, there is no reason for A.O. to doubt same for purpose of allowing deduction against business income. CIT(A) after considering relevant facts, has rightly sustained part of additions and directed A.O. to delete remaining additions. We do not find any error or infirmity in order passed by CIT(A). Hence, we inclined to uphold CIT(A) order and reject ground raised by revenue. 9. next issue that came up for our consideration is disallowance of expenditure incurred under head exchange loss . facts relating to issue are that assessee is involved in business of export of rice and agri commodities. In process, assessee has entered into forward exchange contracts with its bankers to hedge possible fluctuation in foreign currency. During financial year relevant to assessment year 2009-10, assessee has claimed amount of ` 2,57,66,856/- loss on account of exchange loss and claimed as revenue expenditure. During course of assessment proceedings, A.O. observed that assessee has claimed exchange loss, 11 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur however, failed to substantiate loss with necessary underlying exposure i.e. export turnover. A.O. further observed that during financial year relevant to assessment year 2009-10, assessee has achieved zero export turnover and when there is no exports, question of hedging currency does not arise. Accordingly, opined that forward contracts entered by assessee are in nature of speculative transactions and hence, loss is not allowable as business loss etc. A.O. has discussed at length modus operandi of assessee. A.O. also discussed terms forward contracts, derivatives, speculative loss and crystallization losses. According to A.O., loss claimed by assessee is notional loss. A.O. further observed that only crystallized losses are allowable as deduction, but not notional losses. A.O. further observed that assessee has failed to correlate forward contracts with export orders on hand so as to justify need for hedging foreign currency. 10. It is contention of assessee that these forward exchange contracts are entered in previous financial year and matured during current financial year. assessee further contended that during previous financial year, it has achieved more than ` 80 crores export turnover, however, in current financial year because of unexpected 12 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur ban imposed by Government of India, on export of rice, it could not achieve any export turnover. It was further submitted that since forward exchange contracts have been entered in previous financial year, on closure of these forward exchange contracts, banker has debited loss incurred on account of fluctuation in currency and same has been claimed as expenditure. assessee further claims that loss incurred under head exchange loss is crystalised loss, therefore, A.O. was not correct in holding that loss incurred is notional loss. 11. We have heard both parties, perused materials available on record and gone through orders of authorities below. A.O. disallowed loss incurred on forward contracts for reason that loss claimed by assessee is notional loss. A.O. further observed that assessee has failed to correlate exchange loss to export turnover to hedge currency fluctuations, therefore, opined that loss claimed by assessee is not allowable deduction. According to A.O., only crystallized loss on account of closure of forward contracts is allowable as deduction. In present case on hand, assessee has pre-closed forward exchange contracts because of non-availability of export turnover and hence, loss incurred is 13 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur speculative loss within meaning of section 43(5) of Act and hence, it cannot be allowed as deduction. 12. Before we, go in to facts of present case, let us understand, forward contracts, speculative transactions, hedging, foreign exchange loss and treatment of loss in books of accounts. forward contract is agreement between enterprises and banker to purchase or sell particular quantity of currency for mutually agreed price at particular date. These forward contracts are used by exporters to get their export receivables hedged against adverse currency movements. Hedging is defined as to enter in to transactions to reduce risk of adverse movement of currency. Any person having exposure to foreign currency may enter into hedging to fix his cost and profits at particular level. Therefore, forward contracts means entering into agreement with bankers to hedge currency fluctuations to mitigate loss in course of import/export business. Forward exchange contracts and treatment of any profit/loss arising on cancellation or renewal of such forward exchange contracts has been dealt by Accounting Standard-11 issued by Institute of Chartered Accountants of India, in para 36, 37, 38 & 39. According to AS-11, of ICAI, any forward exchange contracts entered to hedge foreign currency exposure, to mitigate 14 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur unexpected loss with its import/export business has to be regarded as business loss and income as case may be. In case of such forward exchange contract is not in nature of hedging, then such loss should be ignored. 13. Similarly, provisions of section 43(5) of Act defines term speculative transactions, means transaction in which contract for purchase or sale of any commodity, including stock and shares is periodically or ultimately settled otherwise than by actual delivery or transfer of commodity or scripts. Sub-clause (a) of section 43(5) of Act, excludes certain transactions within meaning of speculative transaction. According to sub-clause (a), contract in respect of raw materials or merchandise entered into by person in course of his manufacturing or merchandising business, to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him. plain reading of sub-clause (a) of section 43(5) of Act, makes it clear that any forward exchange contracts entered into in its business of import or export of goods to hedge possible fluctuation in foreign currency, then such transactions are kept outside purview of definition of speculative transactions. Therefore, to see whether 15 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur particular transaction is speculative transaction or mere hedging transaction, there should be export or import of goods or merchandise at least to extent of value of forward exchange contracts. 14. treatment to be given to foreign currency items as per amended AS 11 of ICAI, notified by Central Government u/s 211(3C) of Companies Act, does not make any distinction between items of capital nature and revenue nature. Both are required to be recognized in Profit & Loss Account. In view of aforesaid amendment, there exists divergence of views on treatment to be meted out in books of accounts and in Indian Tax Laws. Further, with increased flow of inbound / outbound transactions and their complex dynamic structuring, tax treatment of foreign exchange gains / losses has been surrounded by huge litigation and various Courts have discussed same in great detail. Exchange Fluctuation Difference and tax treatment of captioned issue was discussed in great detail in recent landmark ruling of Supreme Court in case of CIT vs Woodward Governor India P. Ltd (312 ITR 254) where in SC relied on earlier judgment in case of Sutlej Cotton Mills Ltd vs. CIT (116 ITR 1), observed that law may, therefore, now be taken to be well settled that where profit or loss arises to assessee on account of 16 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur appreciation or depreciation in value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if foreign currency is held by assessee on revenue account or as trading asset or as part of circulating capital embarked in business. But, if on other hand, foreign currency is held as capital asset or as fixed capital, such profit or loss would be of capital nature. 15. Further in aforesaid ruling Apex Court also affirmed principles laid down in ruling of CIT vs. V.S.Dempo & Co Pvt. Ltd (206 ITR 291), wherein it was held that loss arising in process of conversion of foreign currency which is part of trading asset of assessee is trading loss as any other loss. In determining true nature and character of loss, cause which occasions loss is immaterial; what is material is whether loss has occurred in course of carrying on business or is incidental to it. If there is loss in trading asset, it would be trading loss, whatever be its cause because it would be loss in course of carrying on business. Loss in respect of circulating capital is revenue loss whereas loss in respect of fixed capital is not. Loss resulting from depreciation of foreign currency which is utilised or intended to be utilised in business 17 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur and is part of circulating capital, would be trading loss, but depreciation of fixed capital on account of alteration in exchange rate would be capital loss. For determining whether devaluation loss is revenue loss or capital loss what is relevant is utilisation of amount at time of devaluation and not object for which loan had been obtained. way in which entries are made by assessee in books of account is not determinative of question whether assessee has earned any profit or suffered any loss. What is necessary to be considered is true nature of transaction and whether in fact it has resulted in profit or loss to assessee. Therefore, once loss incurred on account of fluctuation in foreign currency, then loss suffered shall be allowed as business loss, unless it is in nature of speculation loss. 16. Having said that, let us come to facts of present case. In present case on hand, assessee is into business of export of rice and other commodities. During previous financial year, it has achieved export turnover of about ` 80 crores. forward exchange contracts are entered in previous financial year, which was not disputed by A.O. Though there is no export turnover for current financial year, this is because of ban imposed by Government of 18 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur India, on export of rice and other commodities. As rightly pointed out by Ld. A.R. for assessee, Government of India imposed ban on export of rice for temporary period. Although ban was extended for further period i.e. up to end of financial year 2008-09, assessee was on bonafide belief that ban on export is temporary and Government may review ban, therefore, it can continue its exports and accordingly it has continued its forward exchange contracts with banks. Since ban was continued for whole financial year and also fact that during same period, Indian currency had dramatic fall in international market, assessee has closed forward exchange contracts and suffered loss. assessee being prudent business person entered foreign exchange contracts with hope that Indian currency may recover and it may recoup losses. But, ultimately when things are not turned around, it has cancelled forward exchange contracts, which results into loss. Therefore, loss suffered by assessee cannot be considered as speculative loss within meaning of section 43(5) of Act. 17. Coming to allegations of A.O. A.O. s main allegation is that loss claimed by assessee is MTM loss or notional loss as loss is not crystallized in books of accounts. A.O. observed that only 19 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur crystallized loss is allowable as deductions, but not notional loss. As forward contracts have been entered into against currency fluctuations, there would not be any crystallization of liability. A.O. further observed that loss incurred by assessee is MTM losses, which is in nature of notional loss cannot be allowed as deductions. A.O. referred to AS-30 issued by ICAI and CBDT circular and observed that MTM loss provided in books of accounts cannot be allowed. We do not find merits in findings of A.O., for reason that in present case on hand, A.O. himself has accepted that loss claimed by assessee are on account of cancellation/renewal of forward exchange contracts, which has been debited by bankers. assessee has filed details of forward exchange contracts and bank accounts. On perusal of bank statements, we find that losses incurred by assessee is on account of cancellation/renewal of forward exchange contracts, which is crystallized and debited by bankers. Considering facts and circumstances of this case, we are of view that foreign exchange loss incurred by assessee on account of entering into forward contracts with banks for purpose of hedging loss in connection with its import/export business has to be regarded as business loss. CIT(A) after considering relevant explanations rightly deleted additions made by A.O. We do not see any 20 ITA No.487/Vizag/2012 Sri Ramalingeswara Rice & Oil Mill, Velpur reasons to interfere with order of CIT(A). Hence, we inclined to uphold CIT(A) order and reject ground raised by revenue. 18. In result, appeal filed by revenue is dismissed. above order was pronounced in open court on 7th Oct 16. Sd/- Sd/- (V. DURGA RAO) (G. MANJUNATHA) JUDICIAL MEMBER ACCOUNTANT MEMBER Visakhapatnam: ' /Dated : 7.10.2016 VG/SPS Copy of order forwarded to:- 1. Appellant ACIT, Circle-1, Rajahmundry 2. Respondent M/s. Sri Ramalingeswara Rice & Oil Mills, Dr.No.2-153, Rice Mill Street, Velpur, West Godavari Dist. 3. CIT, Rajahmundry 4. CIT (A), Guntur 5. DR, ITAT, Visakhapatnam 6. Guard file BY ORDER // True Copy // 1 2 (Sr.Private Secretary) ITAT, VISAKHAPATNAM 21 ACIT, Circle-1, Rajahmundry v. Sri Ramalingeswara Rice & Oil Mill, velpur