2016 (9) TMI 638 - AT - Income Tax

Forex Derivatives treating the same as unascertained liability and notional loss - Held that - There is an underlying liability ( Loan) to hedge the risk and hence the derivative contract under consideration is for the purpose of business and not for the purpose to speculate the transaction without and underlying assets and liabilities. In the instant case there is an underlying liability and purpose of this derivative contract is to minimise the business risk by way of hedging therefore it is not a speculative transaction as Ld. DR has pointed out, hence we direct the Ld. CIT (A) to delete the addition. - Decided in favour of assessee. Replacement cost of combers and ring frames - Held that - Each machine including the ring frame was an independent and separate machine capable of independent and specific function and therefore, the expenditure incurred for replacement of the new machine would not come within the meaning of the works current repairs . See M/s Saravana Spinning Mills Pvt. Ltd. 2007 (8) TMI 16 - SUPREME COURT OF INDIA and M/s Sri mangayarkarasi Mills (P) Ltd 2009 (7) TMI 17 - SUPREME COURT . Also on the similar set of facts, the Hon ble ITAT has upheld the action of the assessing officer in treating the expenditure incurred by the assessee as a capital in the assessment year 2005-06 in the assessee s own case, and the CIT (A) has also upheld the action of the Assessing Officer in treating the expenditure incurred by the assessee as a capital expenditure in the assessment year 2006-07 in the assessee s own case. - Decided in favour of assessee. Disallowance under section 14A read with Rule 8D - Held that - Working of Ld CIT(A) as per section 14A , read with Rule 8D seems to be correct. He has rightly excluded the investment made by assessee on 26/03/2008 at ₹ 1,44,804,322 to compute the average amount because the investment was done by the assessee at the end of the accounting year. The Ld.CIT (A) worked out the disallowance as per Rule 8D (2) (ii) by taking opening balance of investment at ₹ 25,57,753/- therefore the total disallowance worked out by him was 25,57,753 x6,38,29029/1815274370 at ₹ 89,936/- whereas as per AO the disallowance was at ₹ 26,26,964/- And as per Rule 8D (2) (iii) the disallowance worked out by him was ₹ 25,57,753 x 0.5 at ₹ 12788/- whereas as per AO the disallowance was at ₹ 3,73,550/-. Thus, out of ₹ 30,00,514/- the CIT(A) has deleted ₹ 28,97,790 (3000514-102724) and retained the addition of ₹ 102724/-. The said working has been done by the Ld.CIT(A) as per the procedure laid down in section 14A read with Rule 8D, therefore we did not find any mistake in the disallowance made by Ld. CIT (A), hence we confirm the order of the Ld. CIT (A).

Summary

Issues Involved:
1. Treatment of Forex Derivatives Loss as Notional Loss.
2. Classification of Replacement Cost of Combers and Ring Frames as Capital Expenditure.
3. Disallowance under Section 14A read with Rule 8D.

Issue-Wise Detailed Analysis:

1. Treatment of Forex Derivatives Loss as Notional Loss:
The assessee challenged the decision of the CIT(A) in upholding the Assessing Officer's (AO) action of treating the mark to market loss on account of Forex Derivatives amounting to ?1,58,94,821/- as notional loss and unascertained liability. The AO added this amount, holding it as a notional loss since the forex derivative contract had not matured by 31/03/2008. The CIT(A) confirmed this action. The assessee argued that as per Accounting Standard-11 and Accounting Standard-30, the loss should be recognized in the Profit & Loss account. The assessee cited the case of Woodward Governor India (P) Ltd. and other judicial precedents supporting the recognition of such losses as business losses. The Departmental Representative (DR) relied on a CBDT Circular and judgments that treated such losses as speculative and not allowable as business expenditure. The Tribunal found merit in the assessee's submissions, noting the underlying liability (Rupee Loan) and the purpose of hedging business risk, and directed the CIT(A) to delete the addition, allowing the assessee's appeal.

2. Classification of Replacement Cost of Combers and Ring Frames as Capital Expenditure:
The assessee contested the CIT(A)'s decision to uphold the AO's treatment of the replacement cost of combers and ring frames amounting to ?4,52,50,588/- as capital expenditure. The AO held that each machine was independent and capable of specific functions, thus not qualifying as 'current repairs.' The AO relied on Supreme Court judgments in the cases of Saravana Spinning Mills Pvt. Ltd. and Sri Mangayarkarasi Mills (P) Ltd., which supported this view. The CIT(A) confirmed this action. The assessee argued that the entire operation in the textile mill should be considered as a single plant, and the replacement did not create new assets but was part of the ongoing production process. The Tribunal found merit in the DR's submissions, supported by the Supreme Court judgments and previous ITAT decisions in the assessee's own case, and upheld the CIT(A)'s order, dismissing the assessee's appeal.

3. Disallowance under Section 14A read with Rule 8D:
The AO disallowed ?30,00,514/- under Section 14A read with Rule 8D, while the assessee had suo-moto disallowed ?1,80,880/-. The CIT(A) deleted the AO's addition but recalculated the disallowance at ?1,02,724/- using Rule 8D. The assessee and the Revenue both appealed this decision. The Tribunal reviewed the CIT(A)'s detailed working, which excluded the investment made at the end of the year and confirmed the disallowance of ?1,02,724/-. The Tribunal upheld the CIT(A)'s order, finding no mistake in the application of Rule 8D and confirming the disallowance.

Conclusion:
The Tribunal allowed the assessee's appeal on the issue of Forex Derivatives Loss, directing the deletion of the addition. However, the Tribunal dismissed the assessee's appeal regarding the classification of replacement costs as capital expenditure and upheld the CIT(A)'s order. On the issue of disallowance under Section 14A read with Rule 8D, the Tribunal confirmed the CIT(A)'s recalculated disallowance, dismissing both the assessee's and the Revenue's appeals.