2022 (7) TMI 1321 - AT - Income Tax

Derivative transaction entered into with the bank for the purpose of securing expected business loss arising out of foreign exchange fluctuation - forex derivative transaction with the ICICI Bank to hedge the foreign currency risk - Addition on account of foreign exchange hedging loss incurred during the course of regular business by treating the same as speculative transaction - definition of speculative transaction given in Section 43(5) - HELD THAT - In the present case the assessee was in the business of manufacturing of yarn processed fabrics and sugar etc., it was not carrying on any trading activity of foreign exchange either in India or outside India since its incorporation. Liability for the hedging contract entered by the assessee with the bank claimed to be in normal course of business started generating heavy liability on account of unexplained fluctuation in the foreign exchange in global market, therefore, the hedging contract were abandoned by the assessee and whatever the liability arose was paid off accordingly the net liability for such hedging had been provided in the books of account as foreign exchange hedging loss and claimed as a revenue expenditure. In our opinion the derivative transaction entered into with the bank for the purpose of securing expected business loss arising out of foreign exchange fluctuation cannot not termed as speculative since the same is particularly carried out to safeguard expected business loss. In the present case the assessee during the course of its regular business entered into derivative contract for the purpose of hedging its business loss arising out of exchange fluctuation in its day to day business activity and there was no element of speculation involved. No derivative contract could be entered into without underlying assets. A derivative means a financial instrument whose value changes in response to change in a specific interest rate, security price, commodity price, foreign exchange rate, index of price or rates, a credit rating or credit index which requires no initial net investment or little net investment relative to other types of contract that have a similar response to changes in market condition and it is settled at a future date, in such type of cases, risk embedded in underlying assets is to be protected by means of derivative contracts invented by the banking institutions but it is neither with the intention nor it can be foreign exchange delivery. It is for the purpose of protection of difference in exchange rate by determination of value of a given currency in a given period. In India, in the case of foreign currency derivative, interest rate derivative and credit derivative, RBI is empowered to regulate for the regulatory purposes. As per the RBI guidelines the user can undertake derivative transaction to hedge specially reduce or extinguish an existing identified risk on an ongoing basis during the life of derivative transactions or for transformation of risk exposure as specially permitted by RBI. The assessee entered into forward contract with the ICICI Bank to hedge the import payments and repayments of the loans therefore the transaction entered into by the assessee was not speculative transaction. Assessee entered into forex derivative transaction with the ICICI Bank to hedge the foreign currency risk involved in the transaction therefore the expenses claimed by the assessee were revenue in nature, for the reasons that the derivative transaction entered into by the assessee was not in the nature of speculative transaction. Assessee entered into forex exchange transaction through its banker with a view to effectively hedge its foreign currency risk therefore these forex derivative transaction are a close proximity or rather incidental to the business of the assessee which cannot be considered as speculative. Assessee entered into hedging contract with its banker i.e; ICICI Bank to minimize the possible fluctuation in foreign currency which resulted in a loss, so it was a business loss or revenue loss. We therefore delete the impugned addition made by the AO and sustained by the Ld. CIT(A). Disallowance by invoking the provisions of Section 14A of the Act read with rule 8D of the Income Tax Rules, 1962 - HELD THAT - Assessee had made the investment in the securities out of common funds, the assessee was also having non interest bearing funds, even there was reduction in the investment during the year under consideration. The assessee also claimed to have received the dividend income through RTGS, therefore the disallowance made by the AO was not justified. Similar issue having identical facts was a subject matter of the assesse s appeal for the preceding assessment year 2010-11 2019 (7) TMI 1601 - ITAT CHANDIGARH direct the AO to verify the calculation made by the assessee vis a vis the calculation made in the earlier year which were accepted by the ITAT and restrict the disallowance accordingly to Rs. 4,39,093/- and since the assessee had already disallowed a sum of Rs. 66,419/- under section 14A(1) of the Act, the said amount is to be reduced and the remaining amount may only be disallowed. Disallowance of the interest paid on working capital loan and long term loan - HELD THAT - As noticed various Courts in the case of Hero Cycles (P) Ltd. 2015 (11) TMI 1314 - SUPREME COURT , Bright Enterprises Pvt. Ltd. 2015 (11) TMI 342 - PUNJAB HARYANA HIGH COURT held that no disallowance of interest is called for where the assessee has got sufficient own funds. The Assessing Officer is directed to go through the fund position namely capital and interest free advances, reserves and surplus to determine whether any borrowed funds have been utilized more than available own funds and take a decision keeping in view the decisions rendered above. If sufficient own funds are available, no disallowance is called for. This ground may be treated as set aside to the file of Assessing Officer.Accordingly this ground is allowed for statistical purposes. Addition under proviso to section 36(1)(iii) on account of borrowed amount utilized from mixed funds lying in C.C. account, for purchase of fixed assets - HELD THAT - No disallowance of interest is called for where the assessee has got sufficient own funds. The Assessing Officer is directed to go through the fund position namely capital and interest free advances, reserves and surplus to determine whether any borrowed funds have been utilized more than available own funds and take a decision keeping in view the decisions rendered above. If sufficient own funds are available, no disallowance is called for. This ground may be treated as set aside to the file of Assessing Officer.Accordingly this issue is decided in favour of the assessee for statistical purposes. Deduction of additional depreciation - HELD THAT - CIT(A) rightly allowed the claim of the assessee by following the decision in the case of Budhewal Co-operative Society 2013 (5) TMI 802 - ITAT CHANDIGARH Income accrued on account of carbon credits - Revenue or capital receipt - HELD THAT - As decided in own case 2015 (12) TMI 1877 - ITAT CHANDIGARH assessee was carrying on the business of power generation for the assessment year 2007-08. Carbon credit was not an offshoot of business of the assessee but an offshoot of environmental concerns. No asset was generated in the course of business but it was generated due to environmental concerns. There was no cost of acquisition or cost of production to get entitlement for the carbon credits. Therefore, the income from sale of carbon credits was to be considered as capital receipt and not liable to tax under any head of income under the Income-tax Act, 1961

Summary

Issues Involved:
1. Foreign Exchange Hedging Loss
2. Disallowance under Section 14A
3. Disallowance under Section 36(1)(iii)
4. Capitalization of Interest under Proviso to Section 36(1)(iii)
5. Additional Depreciation
6. Carbon Credits Entitlements

Detailed Analysis:

1. Foreign Exchange Hedging Loss:
The assessee claimed a deduction of Rs. 13,32,96,175/- as a foreign exchange hedging loss, which the AO treated as a speculative transaction. The AO based this on the fact that the transactions were not carried out on a recognized stock exchange and were not directly related to the business of manufacturing yarn, textile, etc. The CIT(A) upheld this view, stating that the transactions did not qualify as hedging transactions under Section 43(5) of the Act. However, the ITAT reversed this decision, noting that the transactions were entered into to hedge against business losses due to foreign exchange fluctuations, and thus, should be considered as business losses.

2. Disallowance under Section 14A:
The AO disallowed Rs. 1,82,24,640/- under Section 14A read with Rule 8D, which was upheld by the CIT(A). The assessee argued that the disallowance should be limited to the proportionate administrative expenses and interest directly attributable to tax-exempt income. The ITAT directed the AO to verify the calculation provided by the assessee and restrict the disallowance accordingly, following the precedent set in the previous assessment year.

3. Disallowance under Section 36(1)(iii):
The AO disallowed Rs. 1,53,17,042/- under Section 36(1)(iii), attributing it to investments made in shares. The CIT(A) upheld this disallowance, stating that the assessee failed to demonstrate that the investments were made from interest-free funds. The ITAT set aside this issue to the AO, directing him to verify whether the assessee had sufficient own funds to cover the investments and to apply the debt-equity ratio if necessary.

4. Capitalization of Interest under Proviso to Section 36(1)(iii):
The AO capitalized Rs. 2,63,24,29/- as interest on borrowed funds used for acquiring fixed assets, which was upheld by the CIT(A). The ITAT set aside this issue to the AO, directing him to verify the fund position and determine whether sufficient own funds were available to cover the investments in fixed assets.

5. Additional Depreciation:
The AO did not allow the additional depreciation claimed by the assessee during the assessment proceedings on the grounds that it was not claimed in the original return. The CIT(A) allowed the claim, following the ITAT decision in Budhewal Co-operative Society Ltd., which held that claims made during assessment proceedings through a letter are valid. The ITAT upheld this decision, noting that the AO had allowed similar claims in subsequent years.

6. Carbon Credits Entitlements:
The AO treated the carbon credits received by the assessee as revenue receipts. The CIT(A) reversed this decision, treating them as capital receipts, following the ITAT decision in My Home Power Ltd., which was upheld by the Andhra Pradesh High Court. The ITAT upheld the CIT(A)'s decision, noting that the issue was covered by the ITAT's previous order in the assessee's own case for the preceding assessment year.

Conclusion:
The ITAT provided a detailed analysis and directed the AO to re-evaluate certain issues based on the principles established in previous judgments. The appeals were partly allowed for statistical purposes, and the departmental appeals were dismissed.