2016 (7) TMI 1051 - AT - Income Tax

Disallowance u/s 14A r.w.r.8d - plea of the assessee is that Rule-8D(ii) & (iii) is not applicable to the assessee s case as the assessee is having own funds - Held that - The assessee is not able to demonstrate what is the own funds available to the assessee to make investments which yielded exempt income. The fund flow filed by the assessee does not show date on which the assessee made investments out of own funds. Being so, the argument of assessee cannot be the good explanation to hold that the assessee is not incurred interest expenditure on funds used for investments, which yield exempt income.Regarding computation of total asset, the CIT(A) wrongly observed that total assets to be taken before the current liabilities are reduced as per the balance sheet. There is o reason for not reducing the current liabilities. However, we make it clear that total fixed assets after depreciation plus net current assets to be considered as the total asset, when the balance sheet is prepared in Straight Line method while applying the formula in Rule -8D(ii). -Decided partly in favour of revenue Treatment of unabsorbed depreciation - priority for deduction u/s.10B of the Act over set off of brought forward unabsorbed depreciation allowance - Held that - It is held by the Hon ble Karnataka High Court in the case of CIT Vs. Himatsingka Seide reported in 2006 (8) TMI 125 - KARNATAKA High Court held that unabsorbed depreciation has to be adjusted against the income for the purpose of exemption u/s.10B of the Act; exemption u/s.10B cannot be allowed by adjusting only a portion of unabsorbed depreciation of an earlier year against the income of the export unit and adjusted the balance of unabsorbed depreciation against other business income once again to show Nil tax liability. Against this judgement, the assessee carried the matter to Supreme Court by way of SLP, which was dismissed by the Supreme Court. Hence, we are of the opinion that lower authorities have taken the correct view of the facts of the case - Decided against assessee MTM losses on forward contracts - whether are contingent in nature and a provision created on such notional loss cannot be allowed? - Held that - The MTM loss on forward contracts is not contingent loss and it is a business loss to set off against the business income of assessee. However, the AO has to consider the transaction equivalent to the export turnover to determine the MTM loss and also if there is any premature cancellation of forward contract of foreign exchange, it shall be excluded to consider the business loss and these transactions are speculative transaction. With this observation, we remit the issue to the file of AO for fresh consideration.

Summary

Issues Involved:
1. Disallowance under Section 14A of the Income Tax Act.
2. Treatment of unabsorbed depreciation.
3. Marked to Market (MTM) losses on forward contracts.

Detailed Analysis:

1. Disallowance under Section 14A of the Income Tax Act:
The first issue pertains to the disallowance under Section 14A of the Income Tax Act. The assessee had investments in tax-free territories and claimed no expenditure towards operating and maintaining these investments. The Assessing Officer (AO) invoked Rule 8D and disallowed ?15,23,543/-. The CIT(A) upheld the AO's decision, stating that the assessee did not provide sufficient details to demonstrate that no expenditure was incurred to earn exempt income. The CIT(A) also directed that current liabilities should not be eliminated when computing disallowance under Rule 8D(2)(ii). The Tribunal concluded that Rule 8D is applicable since the assessee could not convincingly demonstrate the use of own funds for investments yielding exempt income. It was clarified that total assets should include fixed assets after depreciation plus net current assets, considering the balance sheet prepared in the Straight Line Method. Thus, the assessee's ground was dismissed, and the Revenue's ground was partly allowed.

2. Treatment of Unabsorbed Depreciation:
The next issue involved the priority for deduction under Section 10B over the set-off of brought forward unabsorbed depreciation. The AO set off the brought forward losses first and then granted deduction under Section 10B, leading to the exhaustion of unabsorbed depreciation in preceding years. The Tribunal referenced the Supreme Court's judgment in the case of Himatsingka Seide, which held that unabsorbed depreciation must be adjusted against income for exemption under Section 10B. The Tribunal upheld the lower authorities' view and rejected the assessee's ground.

3. MTM Losses on Forward Contracts:
The third issue concerned the MTM losses on forward contracts, which the AO categorized as speculative and contingent, thus not allowable. The CIT(A) agreed with the AO, referencing CBDT Instruction No.3/2010, which categorized MTM losses as notional and speculative. The Tribunal, however, referenced the ITAT Bangalore's decision in Quality Engineering and Software Technologies Pvt. Ltd., which allowed MTM losses as business losses if they were linked to revenue items and not speculative in nature. The Tribunal emphasized that forward contracts for hedging against foreign exchange fluctuations are not speculative if they are linked to export proceeds. The Tribunal directed the AO to consider the transactions equivalent to export turnover and exclude prematurely canceled contracts. Consequently, the issue was remitted to the AO for fresh consideration.

Conclusion:
The Tribunal dismissed the appeal of the assessee and partly allowed the appeal of the Revenue for statistical purposes. The judgment was pronounced in the open court on 17th June 2016, at Chennai.