2010 (8) TMI 578 - AT - Income Tax

Addition - Forward contract - the assessee evaluates the unmatured forward contracts on the last day of the accounting period on the basis of rate of foreign exchange prevailing on that date and books the loss or profit - income arising from securities and on debenture to the assessee is liable to be taxed on due basis or on the basis of day to day - Supreme Court in the case of another bank, namely United Commercial Bank, 1999 -TMI - 5764 - SUPREME Court - Held that the issue has been decided in favour of the view that the interest accrues only on the specified coupon dates and not on day to day basis - Accordingly the appeal is decided in the favour of the assessee Regarding disallowance on account of broken period interest paid by the assessee - securities had been classified as investments in Schedule -8 to the balance sheet - Merely the classification of the securities as investment in balance sheet is of no consequence and the real income is to be determined as per the return filed by the assessee - Accordingly the ground is dismissed Regarding addition on account of deferred guarantee commission - The fundamental principle of taxing the income under the mercantile system of accounting is time of its accrual - If the guarantee commission was refundable then it cannot be said that absolute right to the commission had accrued in favour of the assessee at the time of execution of contract for furnishing guarantee by it but if the guarantee commission was not depended upon the period of guarantee and, thus, had accrued in favour of the assessee on the date of execution of contract for furnishing guaratnee then the same has to be taxed in the year in which the guarantee was furnished irrespective of the period to which guarantee remained alive - Appeal is allowed by way of remand Regarding interest attributable to investment, dividends from which is exempt from tax - At the time of hearing, it was brought to the notice of both the parties that the issue is pending before the Hon ble Bombay High Court in regard to 14A issue and, therefore, the appeal may be adjourned sine die till the disposal of the same by the Hon ble High Court - Appeal is allowed by way of remand Regarding forward contract - The loss claimed by the assessee is in accordance with a recognized method of accounting - The moot point for consideration is whether keeping in view the nature of contract, can it be said that a liability accrued on 31st March in respect of unmatured forward foreign exchange contract on account of fluctuation in rate of foreign currency or not - the issues relating to accrual of income cannot be decided on the same footing and considerations on which the issues relating to loss/expense is to be decided - Accounting Standard - 11, mandates that in a situation like in the present case, since the transaction is not settled in the same accounting period, the effect of exchange difference has to be recorded on 31st March - when profits are being taxed by the department in respect of such unmatured forward foreign exchange contracts then there was no reason to disallow the loss as claimed by assessee in respect of same contracts on the same footing - Accordingly decided in the favour of the assessee

Issues Involved:
1. Taxation of income from securities and debentures.
2. Disallowance of broken period interest on securities.
3. Deferred guarantee commission.
4. Interest attributable to investments in shares.
5. Loss on forward exchange transactions.

Detailed Analysis:

1. Taxation of Income from Securities and Debentures:
The primary issue was whether the income arising from securities and debentures should be taxed on a due basis or on a day-to-day accrual basis. The assessee recognized income from interest on securities on a day-to-day basis in its books but claimed that interest not due for payment during the previous year should not be included as income. The Assessing Officer (AO) disagreed, stating that income accrues as and when the right to receive it becomes vested. The CIT(A) allowed the assessee's appeal, relying on the Karnataka High Court's decision in Canara Bank and the ITAT Jaipur Bench's decision in State Bank of Bikaner and Jaipur, which held that interest on government securities does not accrue from day to day but only on fixed dates. The Tribunal upheld the CIT(A)'s decision, noting that the issue was covered by precedents in the assessee's own case for previous years.

2. Disallowance of Broken Period Interest on Securities:
The AO disallowed the broken period interest on securities lying in stock-in-trade, treating it as part of the capital cost of the asset. The CIT(A) allowed the assessee's appeal, distinguishing the facts from the Vijay Bank case and aligning with the American Express International Banking Corporation case. The Tribunal upheld the CIT(A)'s decision, noting that the securities were held as trading assets and the profit on their sale was taxed as business profit, not capital gain.

3. Deferred Guarantee Commission:
The AO treated the entire guarantee commission as income in the year the guarantee was given, while the assessee spread it over the period of the guarantee. The CIT(A) allowed the assessee's appeal, relying on the Supreme Court's decision in Madras Industrial Investment Corporation Ltd. and the Calcutta High Court's decision in Bank of Tokyo Ltd., which supported spreading the commission over the guarantee period. The Tribunal restored the matter to the AO to verify if the commission was refundable on premature revocation of the guarantee, which would determine whether it should be spread over the period or taxed in the year of the guarantee.

4. Interest Attributable to Investments in Shares:
The AO disallowed proportionate interest on borrowed funds used for investments in shares, as the dividend income was exempt from tax. The CIT(A) allowed the assessee's appeal, noting that the investment was made from non-interest-bearing funds. The Tribunal restored the issue to the AO for reconsideration in light of the Special Bench decision in Daga Capital Management, which held that section 14A and Rule 8D are retrospective.

5. Loss on Forward Exchange Transactions:
The AO disallowed the loss on revaluation of unmatured forward foreign exchange contracts, treating it as notional. The CIT(A) allowed the assessee's appeal, relying on the ITAT Mumbai's decision in Deutsche Bank A.G., which held that such losses are not notional and should be considered for tax purposes. The Tribunal upheld the CIT(A)'s decision, noting that a binding obligation accrued against the assessee on entering the contracts, and the consistent method of accounting followed by the assessee could not be disregarded. The Tribunal also emphasized that the anticipated losses on account of existing obligations, determinable with reasonable accuracy, should be accounted for as per prudent commercial accounting principles and AS-11.

Conclusion:
The Tribunal's judgment addressed each issue comprehensively, considering relevant precedents and accounting principles. The appeals filed by the revenue were partly allowed for statistical purposes, with some matters restored to the AO for further verification.

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