2016 (12) TMI 623 - AT - Income Tax

Disallowance of loss incurred in hedging against foreign exchange fluctuation - CIT(A) delted the disallowance - Held that - The loss so arisen were on account of abuse of fiduciary powers by the employee therefore allowable as business loss u/s. 28(1). We also found that loss arisen out of cancellation of foreign exchange transactions does not partake the character of speculative transactions nor it qualified as a separate and distinct business to constitute the speculative business. We also found that at the advice of Foreign Exchange Consultants, the assessee company has cancelled the contracts which were unauthorized and booked the loss. The said employee was later terminated from services and criminal complaint was also filed against him. All this shows that the loss was genuine and the said loss was a regular business loss as the transactions were entered by the accused employee with the banks in the name of the assessee company. Accordingly, it was the assessee s duty to bear the loss arising out of cancellation of such unauthorised contracts. Coming to the objection of the AO that loss has been classified as exceptional hence, not permissible as per para 12 of AS-5. When items of income and expense with profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items is required to be disclosed separately . Thus, merely by qualifying it as exceptional loss does not lose the character of business loss and hence has to be allowed. For each and every aspect, the CIT(A) has dealt with the issue threadbare and after controverting the objections of AO and after applying judicial pronouncements to each aspect reached to the conclusion that loss so incurred was allowable as business loss. Disallowance u/s.14A - assessee had made a suo-mote disallowance - assessee had earned dividend income of mainly from Mutual Funds, which has been claimed as exempt u/s. 10(35)- Held that - Though the learned AO acknowledged the fact that borrowed funds have not been utilized for earning exempt income, but he has made further disallowance u/s. 14A r.w.rule 8D at ₹ 84,30,296/- (ie disallowance as per Rule 8D - ₹ 87,86,399/- less expenditure already disallowed in return of income of ₹ 3,56,103/-). While filing the return the assessee had suomoto disallowed proportionate salary of two employees who were engaged in MF activities, and hence the said disallowance of ₹ 3,56,103/- was made. The additional disallowance u/s. 14A requires finding of incurrence of expenditure for earning exempt income. The mere receipt of dividend income would not be sufficient for invoking the provisions of section 14A by applying Rule 8D unless AO record reasons for not accepting the computation of disallowance offered by assessee as attributable to earning of exempt income having regard to the accounts of assessee. AO cannot apply Rule 8D without showing how assessee s method is incorrect. We set aside the matter back to the file of the AO for deciding afresh

Summary

Issues Involved:
1. Disallowance of loss incurred by the assessee in hedging against foreign exchange fluctuation.
2. Disallowance under Section 14A of the Income Tax Act.

Detailed Analysis:

Disallowance of Loss Incurred in Hedging Against Foreign Exchange Fluctuation:
The revenue appealed against the order of CIT(A) which deleted the disallowance of a loss of ?102,99,48,137/- incurred by the assessee in hedging against foreign exchange fluctuation. The assessee claimed this loss as a business loss, attributing it to unauthorized hedging contracts entered by a senior employee, who was later terminated and against whom a criminal complaint was filed. The contracts were entered with various banks including Yes Bank, Kotak Mahindra Bank, IDBI, HSBC, and Deutsche Bank.

The AO disallowed the loss, stating that the transactions were unauthorized and speculative in nature. The AO emphasized that the transactions were not part of the company's normal hedging program and were conducted using forged documents. The AO also argued that the loss was speculative as per Section 73(1) r.w.s. 43(5) of the Income Tax Act, as the transactions were settled otherwise than by delivery.

The CIT(A) overturned the AO's decision, noting that the loss was genuine and incidental to the business. The CIT(A) cited various case laws supporting the claim that losses due to employee misconduct are allowable as business losses. The CIT(A) also clarified that foreign exchange is not a commodity and the contracts were canceled, not settled, thus not falling under speculative transactions as per Section 43(5).

The Tribunal upheld the CIT(A)'s decision, emphasizing that the loss was incurred in the normal course of business and was not speculative. The Tribunal noted that the contracts were canceled to prevent further losses, and the transactions were incidental to the business. The Tribunal relied on judicial precedents, including the Bombay High Court's decision in Badridas Gauridu (P) Ltd and ITAT Mumbai Bench's decision in Voltas International Ltd, to support its conclusion.

Disallowance Under Section 14A:
The assessee had earned dividend income of ?15,32,00,621/- from Mutual Funds, claimed as exempt under Section 10(35) of the Income Tax Act. The assessee made a suo-moto disallowance of ?3,56,103/- under Section 14A. The AO, however, computed the disallowance at ?87,86,399/-, leading to an additional disallowance of ?84,30,296/-.

The Tribunal noted that the AO must record reasons for not accepting the assessee's computation of disallowance. The Tribunal referred to various judicial pronouncements, including the Bombay High Court's decision in Godrej & Boyce Manufacturing Co. Ltd and ITAT Pune Bench's decision in Kalyani Steels Ltd, which emphasize that the AO must objectively determine the correctness of the assessee's claim before invoking Rule 8D.

The Tribunal set aside the matter back to the AO for fresh consideration, directing the AO to apply the judicial propositions to the facts of the case and decide accordingly.

Conclusion:
The Tribunal dismissed the revenue's appeal regarding the disallowance of foreign exchange loss, affirming that the loss was a business loss and not speculative. The cross objection filed by the assessee regarding the disallowance under Section 14A was allowed in part for statistical purposes, with directions for the AO to reconsider the matter in light of judicial precedents.