2012 (10) TMI 223 - AT - Income Tax

Disallowance of expense incurred on earning exempt income - AO has disallowed 10% of the exempted income Held that - Following the decision in case of Godrej & Boyce Mfg. Co. Ltd. (2010 (8) TMI 77 - BOMBAY HIGH COURT) that Rule 8D which has been notified on 24th March 2008 would apply from the A.Y. 2008-09 only. Since we are concerned with the A.Y. 2004-05, the said Rule cannot be invoked. Respectfully following those guidelines issue remand back to AO. Disallowance of renovation expense Renovation expense incurred on leased property, and the lease period is remaining for few months, is a capital or revenue in nature - Assessee took space on lease for a period of five years on lease and license basis Assessee contended that expenditure was incurred wholly and exclusively for the purpose of business - No enduring benefit had accrued to the assessee nor was any capital asset created - Held that - Since the expenditure was incurred in the month of March 2004 as per the terms of the license agreement and the license period was coming to an end in June 2005. They are routine maintenance and repair expenses which the assessee would have had to incur in the normal carrying on of its business. The nature of the work shows that no additional space or capital advantage was derived by incurring the expenditure. Issue decides in favour of assessee. Mark to Market Loss - Disallowance of the provision for loss on Mark to Market basis in respect of trading in derivatives - Assessee holds derivatives as its stock-in-trade - Follows the principle cost or market price, whichever is lower in valuing the derivatives Held that - As the loss due to a fall in price below cost is allowed even if such loss has not been actually realized. The derivatives have been treated as stock-in-trade then there is nothing unusual in the assessee valuing each derivative by applying the rule cost or market whichever is lower. ICAI in its guidelines have also approved of the rule of prudence which really means that while anticipated losses can be taken note of while valuing the closing stock, anticipated profits cannot be recognized. The anticipated loss cannot be treated as a contingent liability. Issue decides in favour of assessee

Summary

Issues:
1. Disallowance of expenses incurred to earn exempted income under section 14A of the Income Tax Act, 1961.
2. Disallowance of renovation expenses on the ground of being capital in nature.
3. Disallowance of provision for loss made on a "Mark to Market" basis in respect of trading in derivatives.

Analysis:

Issue 1:
The first ground of appeal challenged the disallowance of expenses incurred to earn exempted income under section 14A. The appellant contended that recent judgments of the Hon'ble Bombay High Court provided guidelines on the application of section 14A. The Tribunal set aside the orders of the departmental authorities and directed the Assessing Officer to reevaluate the applicability of section 14A in light of the High Court's guidelines. The Tribunal emphasized providing the assessee with an opportunity to present its case adequately.

Issue 2:
The second ground of appeal involved the disallowance of renovation expenses as capital in nature. The appellant argued that the expenses were incurred for routine maintenance and repair as per the leave and license agreement. The Tribunal noted that the expenditure did not result in any enduring benefit or creation of a capital asset. Therefore, the Tribunal held the expenditure as allowable revenue expenditure and directed its allowance.

Issue 3:
The final ground of appeal pertained to the disallowance of a provision for loss made on a "Mark to Market" basis in trading derivatives. The Assessing Officer viewed the provision as a contingent liability that may or may not arise in the future. However, the Tribunal considered the nature of the provision and relevant accounting principles. The Tribunal directed the Assessing Officer to allow the provision, reflecting the loss arising from the valuation of the closing stock of derivatives. The Tribunal emphasized that anticipated losses could be considered while valuing the closing stock, in line with established commercial practices and accounting principles.

In conclusion, the Tribunal partly allowed the appeal, addressing each issue raised by the appellant and providing detailed reasoning for its decisions. The judgment highlighted the importance of following legal guidelines, assessing expenses based on their nature, and considering accounting principles in determining the allowance of provisions for anticipated losses in trading activities.