Foreign exchange loss is not Speculative Loss if

By | September 15, 2015

When will  Foreign exchange loss in forward contract is not speculative Loss and is allowed as Business Loss ?Foreign exchange loss

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 subject to condition that maturity of hedge does not exceed maturity of underlying transaction

From the guidelines issued by the Reserve Bank of India relating to general principles to be observed for forward foreign exchange contracts that the banks have been permitted to enter into such contracts after thorough verification of documentary evidences etc. about the genuineness of the underlying foreign currency exposure and the need of hedging of the loss. Further the maturity of the hedge should not exceed the maturity of the underlying transaction.

In view of the above, it can be safely held that in case of import/export business, where the transactions are demonetarized in the foreign currencies and for the purpose of hedging of the anticipated loss resulting from such import-export business and not otherwise, if the assessee enters into a forward contract in foreign exchange, then such forward contracts are to be treated as integral part or incidental to the business of export/import and cannot be said to be the speculative contracts attracting the provisions of section 43(5). The loss from such hedging transactions would be treated as business loss eligible to be set off against the profits and gains of business and profession. [Para 10]

It is held accordingly that the foreign exchange loss incurred by the assessee on account of entering into forward contracts with the banks for the purpose of hedging the loss in connection with his import/export business cannot be held to be a speculative loss rather a business loss which can be set off against profit and gains of business subject to the condition that the assessee will have to satisfactorily prove that the maturity of the hedge did not exceed the maturity of the underlying transaction. The findings of the Commissioner (Appeals) given are therefore set aside and the issue is restored back to the file of the Assessing Officer to decide the same accordingly. [Para 11]

IN THE ITAT MUMBAI BENCH ‘C’

Perfect Circle India Ltd.

v.

Deputy Commissioner of Income-tax, 5(2), Mumbai

R.C. SHARMA, ACCOUNTANT MEMBER
AND SANJAY GARG, JUDICIAL MEMBER

IT APPEAL NO. 7241 (MUM.) OF 2012
[ASSESSMENT YEAR 2009-10]

MARCH  27, 2015

Rajesh Athavale, A.R. and Prasad Bapat, A.R. for the Appellant. Vivek A. Perampurna, DR for the Respondent.

ORDER

Sanjay Garg, Judicial Member – The present appeal filed by the assessee is directed against the order of the Commissioner of Income Tax (Appeals)-9 [hereinafter referred to CIT(A)], Mumbai, dated 09.10.2012 pertaining to A.Y. 2009-10.

2. The assessee has taken the following grounds of appeal.

“1. On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in confirming the action of AO of disallowance of foreign exchange loss on account of marking to mark to market of forward contracts of Rs.18,22,633
2 On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in confirming the action of AO of disallowance of foreign exchange loss on account of forex derivative contracts of Rs.1,94,000 by treating it as speculation loss.
3 On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in confirming the action of AO of disallowing Professional Fees u/s 40A(2)(b) paid to Anand Automotive Systems Limited of Rs 34,78,043 as excessive and unreasonable.
4 On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in confirming the action of AO of disallowing share of common marketing expenses of Rs 1,44,70,000 u/s 40(a)(ia).”

Additional grounds:

“1. Without prejudice to Ground no 1 of the original ground of appeal the CIT (A) erred in observing that it is the finding given by learned AO that booking and cancellation of forward contracts of exchange were not in respect of specified export or import orders whereas actually the forward coverage was taken by the appellant against the export receivable. (Page 18 Para 5.2.21 of the CIT(A) order)
2 On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in dismissing ground no 2 raised before CIT(A) on the ground that the appellant has not pressed this ground.
3 Without prejudice to Ground No 4 of the original grounds of appeal the learned CIT(A) erred in stating that the learned AR has admitted that it had deducted tax at source while making payment to M/s Anand Automotive Systems Limited, but the appellant failed to deduct tax at source while making payments to M/s Victor Gaskets India Limited.
4 Without prejudice to Ground No 4 of the original grounds of appeal the learned CIT(A) erred in not holding that the payment made to M/s Victor Gaskets India Limited on account of share of common marketing expenses are reasonable and are incurred wholly and exclusively for the purpose of business.
5 Without prejudice to Ground No 4 of the original grounds of appeal and above grounds the payments made to M/s Victor Gaskets India Limited be allowed as per second proviso to Section 40(a)(ia) of the Income Tax Act, 1961.”

Ground No.1 & Additional Ground No.1: Disallowance of loss on mark to market Forward Contracts;

3. The brief facts are that the assessee is engaged in the business of manufacturing rings and semi-finished castings (automobile parts). Assessee entered into forward contracts in order to hedge the risk on adverse currency fluctuation in respect of export realisation to the tune of USD.6,00,000. Export receivable of USD 1,73,670 was hedged and the balance forward contracts of USD 4,26,330 were marked to market. The assessee incurred loss of INR 18,22,633 on mark to market. The Assessing officer held that that the Mark to market losses are purely notional losses. The assessee has not actually suffered any loss and that it was only because that its assets are marked to market and the resultant figure is a loss figure which was a notional figure and was not deductable as business loss under the Income Tax Act. He therefore disallowed the said mark to market loss.

The ld. CIT(A) as per his detailed findings given in the impugned order confirmed the disallowance made by the AO. Being aggrieved, the assessee has preferred the present appeal.

4. Before us, the Ld. AR of the assessee has contended that loss in mark to market contracts was not a notional loss but was an ascertained loss. That the assessee has been taking forward contracts year on year to cover the adverse currency fluctuation risk on export realization and has been consistently accounting open forward contracts on mark to market at the year end and that there was no change in the facts during the year under consideration. The department has been accepting such accounting of mark to market open forward contracts and no adjustment was made in the past as well as in future assessment years. It has been further contended that Forward contracts were taken during the normal course of the business of the assessee and therefore, the mark to market loss on forward contracts should be allowed as deduction under Section 37. Further that the assessee was not a dealer in foreign exchange and that the forward contract in respect of foreign exchange fluctuation risk in respect of export proceeds is excluded from the scope of speculative transactions.

On the other hand the Ld. DR has relied upon the findings of the lower authorities.

5. We have considered the rival submissions. We find that the issue relating to mark to market loss in forward contracts in foreign exchange has come up for consideration before the coordinate bench of this Tribunal and has been decided vide order dated 12.2.2014 in the case of “ACIT v. S. Rajiv & CO.” IT Appeal NO. 7095/Mum 2012, wherein the Tribunal has made the following observations:

‘4. Before us, it has been submitted that this issue had come up for consideration in series of decisions of the co -ordinate bench of the Tribunal. Strong reliance was placed on the latest decision of the Tribunal, Mumbai Bench, in London Star Diamond Co. India Pvt. Ltd. v/s DCIT, ITA no.6169/Mum./2012, order dated 11th October 2013. The relevant conclusion of the Tribunal is as under:—

“35. ** ** **

(a) Loss on cancellation of Matured FCs amounting to Rs. 4,14,88,805 relates to the FCs cancelled or terminated on or after the due date. In other words, the FCs booked as integral part of the export invoices lived its booking period in full and they were either terminated by the Bank on or after due date of maturity date of the contract as the actual realization were not received in time. These are not premature cancellations by the assessee and therefore, in our considered view, the said loss of Rs. 4,14,88,805/-, being related to the FCs which are integral or incidental to the exports of the diamonds, should be allowed as business loss in view of the binding High Court or Tribunal decisions/judgments in the case of D Kishare kumar and Co (supra), Badridas Gauridu Pvt Ltd. (supra), Saaroj Muill Magarmull (supra), etc. Thus, loss arising from cancellation of the matured contracts is allowed in favour of the assessee. Thus, this part of the ground of the assessee is allowed.”

5. Further, we find that this issue has also been decided by the Special Bench of the Tribunal, Mumbai Bench, in DCITv. Bank of Bahrain (supra) wherein the Tribunal, while holding that Mark to Market losses in respect of forward foreign exchange contract debited to Profit & Loss account is an allowable deduction on the following reasoning:—

“(i) A binding obligation accrued against the Appellant the minutes it entered into forward foreign exchange contracts.
(ii) A consistent method of accounting followed by the Appellant cannot be disregarded. The Appellant has consistently followed the same method of accounting in regard to recognition of profit or loss both, in respect of forward foreign exchange contract as per the rate prevailing on March, 31.
(iii) A liability is said to have crystallized when a pending obligation on the balance sheet date is determinable with reasonable certainty.
(iv) As per AS-11, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period.
(v) In view of the decision of the Supreme Court in the case of Woodward Governor India (I) P. Ltd., the Appellant’s claim is allowable.
(vi) In the ultimate analysis, there is no revenue effect and it is only the timing of taxation of loss/profit.’

6. Thus, in view of the above, we uphold the findings of the learned Commissioner (Appeals) for allowing loss incurred by the assessee on re-statement of pending forward contract agreement at the year end as allowable business loss. Thus, the ground raised by the Revenue is treated as dismissed.”

6. It may be further observed that the Hon’ble Supreme Court in the case of ‘CIT v. Woodward Governor India (P.) Ltd.’[2009] 312 ITR 254, while dealing with the question as to whether the additional liability arising on account of fluctuation in the rate of exchange can be allowed to be adjusted pending actual payment of the varied, has observed that “expenditure” as used in section 37 in Income Tax Act may in the circumstances of a particular case cover an amount which is a “loss” even though said amount has not been given from the pocket of the assessee.

7. While dealing with the issue of the nature of forward contracts in commodity derivatives, the co-ordinate bench of the Tribunal in the case of ‘Dy. CIT v. Kotak Mahindra Investment Ltd.’ [2013] 59 SOT 4 (Mum. – Trib.)relating to A.Y. 2008-09, (judicial member of the bench being party to that order also) has observed that such type of forward contracts are not purely contingent in nature rather loss or profit is somewhat ascertainable in such type of contracts because of constant watch on daily market rates. The quantum of profit or loss though not actually ascertainable can be anticipated in view of the trends of the market. The difference between the predetermined price and market price is settled daily on mark-to-market basis. In such type of contracts, it is not the stock value which is subject matter of the contract rather the contract itself is the stock in trade. Contracts in such type of cases can be squared off before the arrival of actual performance of date of contract, as the profit and loss are calculated on daily basis and the margins are settled accordingly.

8. It may be further observed that ‘foreign exchange forward contracts’ entered into for the purpose of hedging the loss in import- export transactions, have been duly recognized and allowed by the Reserve Bank of India. Vide Foreign Exchange Management (Foreign exchange derivative contracts) Regulations, 2000, Notification No. FEMA25/RB-2000, dated 3rd May 2000, Reserve Bank of India has defined the forward contract and foreign exchange derivative contract as under:

“2. (iv) ‘Forward contract’ means a transaction involving delivery, other than Cash or Tom or Spot delivery, of foreign exchange;

(v) ‘Foreign exchange derivative contract’ means a financial transaction or an arrangement in whatever form and by whatever name called, whose value is derived from price movement in one or more underlying assets, and includes,

(a) a transaction which involves at least one foreign currency other than currency of Nepal or Bhutan, or
(b) a transaction which involves at least one interest rate applicable to a foreign currency not being a currency of Nepal or Bhutan , or
(c) a forward contract, but does not include foreign exchange transaction for Cash or Tom or Spot deliveries;”

Further such contracts have been permitted under the following provisions:

“4. Permission to a person resident in India to enter into a Foreign Exchange Derivative contract:—

A person resident in India may enter into a foreign exchange derivative contract in accordance with provisions contained in Schedule I, to hedge an exposure to risk in respect of a transaction permissible under the Act, or rules or regulations or directions or orders made or issued thereunder.” …

“Schedule I

(See regulation 4)

Foreign exchange derivative contract permissible for a person resident in India

A. Forward Contract

1. A person resident in India may enter into a forward contract with an authorised dealer in India to hedge an exposure to exchange risk in respect of a transaction for which sale and/or purchase of foreign exchange is permitted under the Act, or rules or regulations or directions or orders made or issued there under, subject to following terms and conditions) the authorised dealer through verification of documentary evidence is satisfied about the genuineness of the underlying exposure,

(b) the maturity of the hedge does not exceed the maturity of the underlying transaction,

(c) the currency of hedge and tenor are left to the choice of the customer,

(d) where the exact amount of the underlying transaction is not ascertainable, the contract is booked on the basis of a reasonable estimate,

(e) foreign currency loans/bonds will be eligible for hedge only after final approval is accorded by the Reserve Bank where such approval is necessary,

(f) in case of Global Depository Receipts (GDRs) the issue price has been finalised,

(g) balances in the Exchange Earner’s Foreign Currency(EEFC) accounts sold forward by the account holders shall remain earmarked for delivery and such contracts shall not be cancelled. They may be ,however, be rolled-over,

(h) contracts involving rupee as one of the currencies, once cancelled shall not be re-booked although they can be rolled over at ongoing rates on or before maturity. This restriction shall not apply to contracts covering export transactions which may be cancelled, rebooked or rolled over at on-going rates,

(i) substitution of contracts for hedging trade transactions may be permitted by an authorized dealer on being satisfied with the circumstances under which such substitution has become necessary.” (Emphasis supplied)

9. We may further observe from the guidelines issued by the Reserve Bank of India relating to general principles to be observed for forward foreign exchange contracts that the banks have been permitted to enter into such contracts after thorough verification of documentary evidences etc. about the genuineness of the underlying foreign currency exposure and the need of hedging of the loss. Further the maturity of the hedge should not exceed the maturity of the underlying transaction.

10. In view of the above discussions, it can be safely held that in case of import/export business, where the transactions are demonetarized in the foreign currencies and for the purpose of hedging of the anticipated loss resulting from such import-export business and not otherwise, if the assessee enters into a forward contract in foreign exchange, then such forward contracts are to be treated as integral part or incidental to the business of export/import and cannot be said to be the speculative contracts attracting the provisions of section 43(5) of the Act. The loss from such hedging transactions would be treated as business loss eligible to be set off against the profits and gains of business and profession.

11. It is held accordingly that the foreign exchange loss incurred by the assessee on account of entering into forward contracts with the banks for the purpose of hedging the loss in connection with his import/export business cannot be held to be a speculative loss rather a business loss which can be set off against profit and gains of business subject to the condition that the assessee will have to satisfactorily prove that the maturity of the hedge did not exceed the maturity of the underlying transaction. The findings of the CIT(A) given vide impugned order are therefore set aside and the issue is restored back to the file of the AO to decide the same accordingly after giving proper opportunity to the assessee to represent its case.

Ground No. 2 & Additional Ground No.2: Disallowance of foreign exchange loss on cancellation of forward contracts of Rs.194000/- :

12. The Ld. AR of the assessee has stated at Bar that as per instructions of his clien, he does not press this Ground. He has also signed on the memo of Grounds of appeal in this respect. We also find from the record that this ground has not been pressed by the assessee before the Ld. CIT(A) also. Ground No. 2 is therefore dismissed being not pressed.

13. Ground No.3: Disallowance of Professional fees paid to Anand Automotive Systems Ltd. INR 34,78,043 being 20% of INR 1,72,90,218 as not being incurred wholly and exclusively for the purpose of business :

While scrutinizing the expenses of the assessee, the AO noticed that the assessee had claimed a sum of Rs. 1,23,90,218/- as professional fees paid to one of its sister concern M/s. Anand Automotive Systems Limited. The AO asked the assessee to justify the same. In response, the assessee replied that the it had paid the said amount to M/s. Anand Automotive Systems Limited for providing HRD, Marketing, Finance, Legal and Taxation, Operation Review, Facilities, Government Liaison, Corporate Relations and Communication and Support. However, the assessee failed to quantify the services rendered by the said M/s. Anand Automotive Systems Limited. In the absence of any such quantification of services actually rendered by the said sister concern, the AO disallowed 20% of the expenditure paid to M/s. Anand Automotive Systems Limited.

In appeal, the Ld. CIT(A) also confirmed the addition made by the AO on this account.

14. Before us, the Ld. AR has submitted that the assessee belongs to Anand Group of Companies. Assessee entered into Corporate Services Agreement with Anand Automotive Systems Ltd. (AASL). It has been contended by the assessee that the AASL was set up with the idea of providing under one roof various professional, financial, tax, management and other consultancy services including training to its client in these areas. The company has also been providing transit house facilities. These services have been provided either through its own infrastructure or by procuring the necessary professional inputs from third parties. AASL is, therefore, a service company, the services rendered by which are for the benefit of companies belonging to the Anand Group. Professional fees paid to AASL was wholly and exclusively for the purpose of assessee’s business. Assessee has been paying professional fees and rent to Anand Automotive Systems Ltd. for last 10-12 years and no such disallowance has been made in the past. It has been further conteded that as there is no change in the facts during the year under appeal, no ad-hoc disallowance should be called for. It has been further submitted by the Ld. AR that ad-hoc addition (20% of cost) made in the hands of AASL for AY 2008-09 by stating that less professional fees received by AASL from Anand group companies has been deleted by the ITAT vide order dated 28.06.2013 in ITA No. 1343/M/2012) further that the ad-hoc addition (20% of cost) made in the hands of AASL for AY 2009-10 has been set aside to the AO by the ITAT vide order dated31.01.2013 in ITA No. 7165/M/2012 and in the set aside proceedings, the AO also deleted the said addition vide order dated 19.02.2014.

The Ld. DR, on the other hand has relied upon the findings of the lower authorities.

15. We have considered the rival contentions. The AO in the case in hand has disallowed the expenditure incurred/paid to AASL being excessive or not relating to the business activity of the assessee, the department on the other hand had made the additions in the hand of AASL on the ground that the income/consideration for services provided by AASL to the assessee in this case was less and therefore adhoc addition had been made in the case of AASL. Thus the department has taken a contradictory stand. Under such circumstances it is difficult to believe that the payment made by the assessee to AASL for the services obtained was excessive or that it was not relating to the business of the assessee. This ground is accordingly allowed in favour of the assessee.

16. Ground No.4; Additional Ground No. 3, 4 & 5: Disallowance of sharing of common marketing expenses with Victor Gaskets India Limited INR 1,44,78,000 u/s.40(a)(ia) and without prejudice, 20% disallowed as not being incurred wholly and exclusively for the purpose of business :

The AO also noticed that the appellant had paid a sum of Rs. 1,44,78,000/- to M/s. Victor Gaskets India Limited (VGIL). These payments were made in terms of the contract between the appellant and the said M/s. Victor Gaskets India Limited; but the assessee had failed to deduct taxes on the said payment of Rs. 1,44,78,000/- paid to the said M/s. Victor Gaskets India Limited. The AO show caused the assessee as to why the said sum of Rs. 1,44,78,000/- should not be disallowed under section 40(a)(ia) of the Act. The assessee denied the TDS liability and said that the provisions of section 40(a)(ia) were not applicable. The AO examined the contract between the assessee and the said M/s. Victor Gaskets India Limited. The AO was of the view that the provisions of section 194C of the Act were clearly attracted and since the tax at source was not deduted by the assessee, he, therefore, disallowed the said amount of Rs. 1,44,78,000/- under section 40(a)(ia) of the Act. Without prejudice, he disallowed 20% of the same, as excessive and unreasonable. However, since the entire expenditure was disallowed under section 40(a)(ia) of the Act, hence, no separate disallowance of 20% of Rs. 1,44,78,000/- was made.

In appeal, the Ld. CIT(A) confirmed the findings of the AO.

17. Before us, the ld. AR has contended on behalf of the assessee that the assessee entered into an agreement with Victor Gaskets India Limited for sharing of common market expenses. As per the agreement the expenses were incurred by Victor Gaskets India Limited. The assessee had reimbursed the expenses on the basis of debit notes received from Victor Gaskets India Limited at the rate of 60 % of the total expenses. It has been further contended that although the assessee’s representative admitted before the CIT(A) that the assessee should have deducted tax at source of such payment, however it is a fact that payments made to Victor Gaskets was actual reimbursement of expenses without any mark-up and therefore, the such reimbursement was not in the nature of income. Therefore, no tax was required to be deducted on such reimbursement of expenses. Without prejudice to the above, it has been further submitted that since Victor Gaskets India Limited has filed its return of income, such reimbursement of marketing expenses in its return of income for the AY 2009-10 and paid the taxes on such returned income, no disallowance can be made as per 2nd proviso to Section 40(a)(ia) of the Income tax Act. It has been further contended that the said expenses had been incurred wholly and exclusively for the purpose of business and therefore, the same should be allowed entirely. Even the CIT(A) had deleted the disallowance of identical expenses in the earlier assessment year- AY 2008-09, which has been further confirmed by the ITAT by rejecting the Department’s appeal ITA No. 2350/M/2012.

18. We have considered the rival contentions of both the parties. We find that the copy of the service agreement of the assessee with Victor Gaskets India Ltd. has been placed on paper book file at page No.104. We have perused the said agreement. We find that the assessee has entered into a specific agreement of service with VGIL and it has been agreed that the VGIL will provide to the assessee the marketing services all over India besides that it will handle mechanic service/sale promotion/Van campaign etc. activities on behalf of the assessee. It may be noted that whereas VGIL is engaged in the manufacture and sale of gaskets and whereas the assessee is engaged in manufacture and sale of pastern rings, semi finished castings and lapping sleeves. The said VGIL had agreed to provide the services as detailed above to the assessee and besides that it had been engaged in promotion of its own products also. As per the agreement, the assessee has been made liable to pay 60% of the expenses incurred by the VGIL in market/promotion of the products. It is not a case of reimbursement of actual expenses incurred by the VGIL on behalf of the assessee. Whereas it is a case of composite agreement as per which the assessee has been made liable to pay 60% of the total and expenses incurred by the VGIL for marketing of its own products and that of assessee, which means that the assessee has been paying service charges to the VGIL who has been providing marketing services to the assessee. Further, it has been specifically provided in clause 8 of the agreement that the VGIL shall at all times be an independent contractor and nothing contained in the agreement shall in any way imply employer-employee relationship, principal-agent relationship or a commercial-agent relationship. These clauses in the agreement prove beyond doubt that the VGIL has been providing the services to the assessee as an independent contractor. Hence, the assessee was liable to deduct tax at source as per the provisions of chapter XVII-B of the Act and therefore disallowance was attracted in this case under section 40(a)(ia) of the Act.

19. The next contention of the ld. counsel for the assessee has been that a new proviso has been inserted in section 40(a)(ia) vide Finance Act, 2012 w.e.f. 01.04.13 wherein it has been provided that if the assessee fails to deduct TDS in respect of any payment to which the TDS provisions apply but he is not deemed to be an assessee in default under section 201 of the Act, which provides that if the payee of the such amount computed the same into his income tax return and has paid the due taxes, then such an assessee will not be deemed to be an assessee in default. The relevant provisions of section 40 (a)(ia) including the newly inserted proviso, for the sake of convenience are reproduced as under:

“Amounts not deductible:

40. Notwithstanding anything to the contrary in sections 30 to 64, the following amounts shall not be deducted in computing the income chargeable under the head “Profits and gains of business or profession”, —

(a) ** ** **

(ia) any interest, commission or brokerage, 67rent, royalty, fees for professional services or fees for technical services payable to a resident, or amounts payable to a contractor or sub-contractor, being resident, for carrying out any work (including supply of labour for carrying out any work), on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, 68has not been paid on or before the due date specified in sub-section (1) of section 139 :

69Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid :

70Provided further that where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purpose of this sub-clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the resident payee referred to in the said proviso.”

“70. Inserted by the Finance Act, 2012, w.e.f. 1-4-2013.”

Section 201 of the Act being also relevant is reproduced as under:

“Consequences of failure to deduct or pay:

201. (1) Where any person, including the principal officer of a company, —

(a) who is required to deduct any sum in accordance with the provisions of this Act; or
(b) referred to in sub-section (1A) of section 192, being an employer, does not deduct, or does not pay, or after so deducting fails to pay, the whole or any part of the tax, as required by or under this Act, then, such person, shall, without prejudice to any other consequences which he may incur, be deemed to be an assessee in default in respect of such tax:

21Provided that any person, including the principal officer of a company, who fails to deduct the whole or any part of the tax in accordance with the provisions of this Chapter on the sum paid to a resident or on the sum credited to the account of a resident shall not be deemed to be an assessee in default in respect of such tax if such resident –

(i) has furnished his return of income under section 139;
(ii) has taken into account such sum for computing income in such return of income; and
(iii) has paid the tax due on the income declared by him in such return of income, and the person furnishes a certificate to this effect from an accountant in such form as may be prescribed”

“21. Inserted by the Finance Act, 2012, w.e.f. 1-7-2012”

20. The Ld. counsel for the assessee has relied upon various case laws to press the point that the newly inserted proviso to section 40(a)(ia) is in fact clarificatory in nature and should be applied/retrospectively.

20.1 On the other hand, the ld. D.R. has contended that it has been specifically provided in the Act that the said proviso comes into operation w.e.f. 01.04.13 and that where the language of the section as well as the date of operation of such provisions has been mentioned specifically the courts cannot supply words to the provisions or amend the provisions to give it a different meaning and further that the newly inserted proviso under such circumstances is prospective in nature i.e. w.e.f. 01.04.13 and cannot be applied retrospectively.

21. The Ld. A.R. of the assessee has brought to our notice that the issue relating to operation of the newly inserted proviso whether prospective or retrospective in nature has already been considered and decided by the co-ordinate Bangalore bench of the Tribunal in the case of “S.M. Anand v. ACIT” IT Appeal No.183/Bang./13 for A.Y. 2005-06 vide order dated 21.02.14. The relevant part of the findings of the Tribunal given in the said case, are reproduced as under:

“3.4.1 We have heard the rival submissions and perused and carefully considered the material on record. Admittedly, the assessee has not deducted tax at source on the payments made to Sri G. Shankar of Rs. 2,69,21,500 and to Sri Ramesh Kotian of Rs.1,54,75,000. As pointed out by the learned Authorised Representative as far as the payments made to the aforesaid two persons is concerned the fact that the said payees/recipients have shown the said amounts in their respective books of account and profit and loss accounts and also that the same has been offered to tax in their returns of income is not controverted by the authorities below. In our considered opinion, since the payees/recipients i.e. G. Ramesh and Ramesh Kotian have already shown these amounts in their respective books of account audited under section 44AB of the Act; declared and offered the same to tax in their returns of income for the relevant period, thus by virtue of the amendment to the provisions of section 40(a)(ia) of the Act by insertion of the second proviso to section 40(a)(ia) of the Act w.e.f. ;1.4.2013, the provisions of section 40(a)(ia) of the Act would not be attracted to the payments made by the assessee i.e. Sri G. Shankar of Rs.2,69,21,500 and to Sri Ramesh Kotian of Rs.1,54,75,000. This view of ours, is in accordance with the decision of the co-ordinate bench of this Tribunal in the case of Ananda Markala (supra) wherein it was held that the insertion of the second proviso to section 40(a)(1a) of the Act should be read retrospectively from 1.4.2005 and not prospectively from 1.4.2013. In this view of the matter, the provisions of section 40(a)(ia) of the Act is not attracted to the payments made by the assessee to Sri G. Shankar of Rs.2,69,21,500 and to Sri Ramesh Kotian of Rs.1,54,75,000 since the object of introduction of section 40(a)(ia) of the Act is achieved for the reason that the payees/recipients have declared and offered to tax the payments received from the assessee in their respective hands.

3.4.2 As regards the issue of non-furnishing of Form No.26A, we are of the view that since the second proviso to section 40(a)(ia) of the Act is held to be retrospective in operation w.e.f. 1.4.2005, similarly, Form 26A was to be filed for an assessee not to be held as an assessees in default as per proviso to section 201 of the Act. In all fairness, the assessee in the period under consideration i.e. Assessment Year 205-06 could not have contemplated that such a compliance was to be made and therefore in the interest of equity and justice we set aside the order of the learned CIT (Appeals) and remit the matter to the file of the Assessing Officer directing the Assessing Officer to consider the allowance or otherwise of the expenditure claimed amounting to Rs.4,23,96,500; being the payments made by the assessee to Sri G. Shankar of Rs.2,69,21,500 and to Sri Ramesh Kotiar, of Rs.1,54,75,000 after affording the assessee adequate opportunity to file Form No.26A and only after due verification of whether the aforesaid two payees/recipients have reflected the same receipts in their books of account and have offered the some to tax. In these circumstances, we hereby set aside the order of the learned CIT (Appeals) to the file of the Assessing Officer only for the limited purpose as directed above.”

22. We agree with the above finding of the co-ordinate bench of the Tribunal and respectfully following the same, we hold that disallowance under section 40(a)(ia) of the Act will not be attracted, if the respective payee has paid the required taxes in accordance with law. For verification of the actual position, we restore this issue to the file of the AO to verify whether the VGIL had paid the due taxes after computation of its income including the payments received from the assessee. This issue is accordingly allowed for statistical purposes.

23. So far the issue relating to the adhoc disallowance @20% of the expenses is concerned, we do not find any justification for the same on the part of the lower authorities. We hold that if the claim of the assessee, otherwise will be found to be eligible for deduction in view of our findings given above relating to the alternate contention of the assessee, then no disallowance will be called for on adhoc basis.

With the above observations, the appeal of the assessee is hereby partly allowed.

Leave a Reply