2016 (8) TMI 1094 - AT - Income Tax

Addition u/s 14A - Held that - The investments which has not yielded dividend or tax free income during the year should only be included, no supporting decision has been placed before us by the ld. Counsel before us that only the investments which have not yielded the exempt income during the year has to be excluded. Rule 8D(2)(iii) lays down that, an amount equal to % of the average value of the investment, income from which does not or shall not form part of the total income, as appearing in the Balance-sheet of the assessee ,on the first day and the last day of the previous year shall be taken. What is required to be seen is, whether the income from the investment which does not or shall not form part of the income. The phrase does not conveys something done or to be done in present, that is, income during the year ; and shall not conveys something about in future, a strong assertion or intention, that is, not earned income in future . Hence in our opinion, the phrase shall not covers a situation where income earned in future or whenever it is earned, then it shall not form part of the total income at any time. Thus, this contention of the assessee prima facie does not appears to be in correct interpretation or in line with the Rule 8D(2)(iii). Accordingly, we direct the AO to remove the strategic investments only from the working and from the balance, he should work out the disallowance as per Rule 8D (2)(iii). Loss on account of foreign currency forward/option contracts - Held that - Hedging is often done based on actual estimated exposure looking to the past transactions undertaken and based on that, hedging is done in respect of transaction yet to be done in the near future. Bill to bill or one to one basis exposure of hedging cannot be done in a continuum business and nothing has been brought on record that RBI puts such kind of condition or bar for hedging of foreign currency based on actual bill to bill exposure. Hedging contracts need not succeed the contract for sale and actual goods manufactured but may get settled within a reasonable time. Quantity and timing may not be relevant for a short period in a continuous transaction as long as transaction construed is based on genuine hedging and finally it coincides with the actual exposure undertaken. It is only at the year end that one can still reconcile the hedging transactions with the actual exposure or delivery and come to a conclusion whether hedging contract exceeded the actual exposure or not but certainly not on week to week or month to month basis. Thus, the disallowance of loss sustained by the Ld. CIT(A) of ₹ 8,23,26,649/- cannot be upheld simply on the ground that the exposure do not tally with the month-wise transaction. In view of our above conclusion, we allow the claim of ₹ 8,23,26,649/- and accordingly, the grounds raised by the assessee is allowed.

Issues Involved:
1. Disallowance under Section 14A by applying Rule 8D in respect of Dividend income.
2. Classification of foreign currency forward/option contracts losses as either business loss or speculation loss.

Issue-wise Detailed Analysis:

1. Disallowance under Section 14A by applying Rule 8D in respect of Dividend income:

The assessee, a Star Trading House in the diamond business, earned dividend income of ?62,92,640/- exempt under Section 10(34). The AO disallowed ?25,85,318/- under Section 14A by applying Rule 8D, arguing that the assessee had a common pool of funds and composite books of accounts, making it impossible to identify expenses attributable to earning this exempt income. The AO calculated the disallowance of interest at ?14,000,41/- and indirect expenses at ?11,85,278/-.

The CIT(A) confirmed the disallowance, citing the Hon’ble Bombay High Court's decision in Godrej Boyce Mfg. Co. Ltd. The assessee contended that it had surplus funds exceeding the investments, referencing CIT vs. Reliance Utilities and Power Ltd. and CIT vs. HDFC Bank. The assessee also argued that strategic investments in subsidiaries should not be considered for disallowance.

The Tribunal held that the surplus and interest-free funds available with the assessee exceeded the investments, implying that investments were made from surplus/interest-free funds. This aligned with the Bombay High Court's decisions, leading to the deletion of the interest disallowance under Rule 8D(2)(ii). However, the Tribunal directed the AO to exclude strategic investments from the disallowance calculation under Rule 8D(2)(iii) but rejected the contention that only investments yielding exempt income during the year should be considered.

2. Classification of foreign currency forward/option contracts losses as either business loss or speculation loss:

The assessee reported a net loss of ?26,18,34,176/- due to foreign exchange rate differences, including a loss of ?49,23,23,597/- from foreign currency forward/option contracts. The AO classified this as speculation loss under Section 43(5), arguing that the transactions were not hedging transactions and lacked specific bills or delivery.

The CIT(A) partially agreed, treating ?8,33,76,649/- as speculation loss and ?40,89,46,948/- as business loss. The CIT(A) recognized that the assessee's foreign currency transactions were integral to its diamond business and not a separate business. However, the assessee failed to substantiate the underlying exposure for part of the derivative contracts.

The Tribunal noted that the assessee's business involved significant foreign currency transactions for imports and exports, making foreign exchange fluctuations an integral business risk. The Tribunal referenced the Bombay High Court's decision in Badridas Gauridu, which held that foreign exchange losses from hedging transactions in the regular course of business are business losses. The Tribunal found that the assessee's transactions were genuine hedging activities and not speculative. Consequently, the Tribunal allowed the entire loss of ?49,23,23,597/- as a business loss, including the previously disallowed ?8,23,26,649/-.

Revenue's Appeal:

The revenue's appeal contested the CIT(A)'s decision to treat only ?8,33,76,649/- as speculation loss. Given the Tribunal's findings that the entire loss was a business loss, the revenue's appeal was dismissed.

Conclusion:

The assessee's appeal was partly allowed, and the revenue's appeal was dismissed. The Tribunal directed the deletion of the interest disallowance under Rule 8D(2)(ii) and exclusion of strategic investments from the disallowance calculation under Rule 8D(2)(iii). The entire foreign currency forward/option contracts loss was treated as a business loss.

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