2016 (1) TMI 133 - AT - Income Tax

Disallowance u/s.14A of the Act by invoking Rule 8D - Held that - Though Rule 8D of Income Tax Rules 1962 is not applicable, and provisions of Sec.14A of the Act is only applicable for the assessment year 2008-2009 as the Rule was introduced w.e.f. 24.03.2008. The assessee might have incurred certain administrative expenditure to earn this income. Thus we are inclined to direct the Assessing Officer to disallow 2% of exempt income towards expenditure incurred to earn exempt income. - Decided partly in favour of assessee Exclusion of interest on the margin money deposited with the bank while computing the deduction u/s.10B - Held that - Similar issue was considered by Madras High Court in the case of Dollar Apparels vs. ITO (2007 (2) TMI 120 - HIGH COURT, MADRAS) wherein it was held that interest on deposits with bank even assuming that the bank had insisted for making short term deposits for opening letters of credit is not income derived from export business hence not eligible for deduction u/s.80HHC Disallowance u/s 14A - Held that - Disallowance u/s.14A r.w. Rule 8D should not exceed the exempt income. The Mumbai Bench in the case of M/s. Daga Global Chemicals Pvt. Ltd. 2015 (1) TMI 1204 - ITAT MUMBAI sustained the disallowance on applicability of provisions of sec.14A r.w. Rule 8D. However, the alternative claim of the assessee was that disallowance if at all should be made, it should be restricted to exempt income earned and not beyond that. Accordingly, the AO is directed to look at this issue on this angle and decide it afresh. Loss on account of cancellation of forward contracts in forex derivatives - business loss OR speculation loss - Held that - In this case, the Commissioner of Income Tax (Appeals) given an direction to the Assessing Officer to verify any forward contracts have been cancelled prematurely and verify the reasons for premature cancellation in the light of the order of the Tribunal in the case of London Star Diamond Company (I) P. Ltd vs. DCIT 2013 (11) TMI 424 - ITAT MUMBAI wherein it was observed that loss arising from cancellation of premature is allowed as business loss. Being so, the assessee cannot have any grievance on this issue as Commissioner of Income Tax (Appeals) has given direction to follow the Tribunal order. Further, we make it clear that loss arising out of derivative transaction in excess of export turnover has to be considered as speculative loss because excess derivative transaction has no proximity with export turnover.

Issues Involved:
1. Principles of equity, natural justice, and fair play.
2. Disallowance under Section 14A read with Rule 8D of the Income Tax Rules, 1962.
3. Exclusion of interest on margin money deposited with the bank while computing deduction under Section 10B.
4. Levy of interest under Sections 234B and 234C.
5. Treatment of loss on account of cancellation of forward contracts in forex derivatives as business loss or speculation loss.

Detailed Analysis:

1. Principles of Equity, Natural Justice, and Fair Play:
The first ground raised by the assessee was that the order passed by the lower authorities was opposed to the principles of equity, natural justice, and fair play. However, this ground was not pressed by the Authorized Representative at the time of hearing. Consequently, this ground was dismissed as not pressed.

2. Disallowance under Section 14A read with Rule 8D:
The assessee challenged the disallowance of Rs. 94,83,093/- made by the Assessing Officer (AO) under Section 14A read with Rule 8D(ii). The assessee contended that no expenditure was incurred for earning exempt income and that investments were made from free funds, not borrowed funds. The Tribunal noted that Rule 8D was not applicable for the assessment year 2008-2009 but held that certain administrative expenditure must have been incurred to earn the exempt income. The Tribunal directed the AO to disallow 2% of the exempt income towards expenditure incurred, partly allowing the appeal.

In subsequent appeals, the Tribunal reiterated that disallowance under Section 14A read with Rule 8D should not exceed the exempt income, following the Mumbai Bench's decision in M/s. Daga Global Chemicals Pvt. Ltd. The AO was directed to re-examine the issue in light of this decision, partly allowing the appeals.

3. Exclusion of Interest on Margin Money Deposited with the Bank (Section 10B):
The assessee claimed deduction under Section 10B on interest income from bank deposits, arguing that the interest earned on deposits given as collateral for export credit had a direct nexus with the industrial undertaking. The Tribunal referred to the Madras High Court's decision in Dollar Apparels vs. ITO, which held that interest on bank deposits is not income derived from export business and thus not eligible for deduction under Section 80HHC. The Tribunal applied this ratio and dismissed the assessee's ground.

4. Levy of Interest under Sections 234B and 234C:
The assessee contested the levy of interest under Sections 234B and 234C. The Tribunal noted that the interest is consequential and mandatory in nature and should be considered by the AO while passing the consequential order. Thus, the appeal on this ground was dismissed.

5. Treatment of Loss on Cancellation of Forward Contracts in Forex Derivatives:
The AO disallowed the assessee's claim of loss of Rs. 69,26,01,324/- on account of cancellation of forward contracts in forex derivatives, treating it as speculation loss under Section 43(5). The Commissioner of Income Tax (Appeals) and the Tribunal both referred to various judicial precedents, including the Supreme Court's decision in Woodward Governor India and the ITAT Mumbai's decision in London Star Diamond Company (I) P Ltd. The Tribunal upheld the Commissioner of Income Tax (Appeals)'s direction to the AO to verify whether any forward contracts were prematurely canceled and to allow the loss as business loss if justified. The Tribunal also clarified that loss arising from derivative transactions in excess of export turnover should be considered speculative loss. The appeals were partly allowed with these observations.

Conclusion:
The appeals were partly allowed, with specific directions given to the AO for re-examination and verification of certain issues, particularly concerning disallowance under Section 14A read with Rule 8D and the treatment of loss on cancellation of forward contracts in forex derivatives. The Tribunal upheld the principles of equity, natural justice, and fair play, ensuring that the AO follows judicial precedents and provides a fair assessment.

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