2018 (11) TMI 254 - AT - Income Tax

Disallowance of loss claimed on mark to market on account of trading of derivative instruments by treating the same as notional loss and treating the same as contingent liability - AO held this is unascertained liability and merely provision and hence cannot be allowed - Held that - The assessee is booking profits on derivatives as and when it is valued at the end of the year and as and when the loss is arising the same is claimed as deduction. This practice is followed by assessee regularly and Tribunal in assessee s own case in immediate preceding year i.e. AY 2011-12 as allowed the claimed of the assessee respectfully following the same we allow the claim of the assessee. This issue is exactly identical in these four appeals of Revenue hence taking a consistent view we dismiss this issue of Revenue s appeals. Disallowance of expenses relatable to exempt income by the AO by invoking the provisions of Section 14A of the Act read with Rule 8D(2)(ii) & (iii) - Held that - Once this is the position the issue is squarely covered by following the case of CIT vs. HDFC Bank Ltd. 2014 (8) TMI 119 - BOMBAY HIGH COURT . Respectfully following the Bombay High Court decision and considering the facts of the case we are of the view that the CIT(A) has rightly deleted the addition and we confirm the same. AO can verify the investment giving exempt and investments which are kept as stock in trade can be disallowed. Apart from that the assessee has recomputed the disallowance which may be accepted. We find that the plea of the assessee is quite reasonable and hence accordingly we restore this issue back to the file of the AO who will determine the investment held in stock in trade and he will disallow the interest only on the investments kept as stock in trade but only qua the investment giving exempt income. Accordingly this issue of Revenue s appeal is partly allowed for statistical purposes.

1. ISSUES PRESENTED and CONSIDERED

The legal judgment primarily addresses the following core issues:

Whether the CIT(A) erred in allowing the provision for mark to market on trading of derivative instruments by treating it as notional loss and whether such a loss can be considered a contingent liability under the Income Tax Act.
Whether the CIT(A) erred in deleting the disallowance of expenses related to exempt income by the AO under Section 14A of the Act read with Rule 8D(2)(ii) & (iii) of the Rules.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Mark to Market Loss on Derivative Instruments

Relevant Legal Framework and Precedents: The primary legal framework involves the provisions of the Income Tax Act, particularly around the treatment of notional losses and contingent liabilities. The CBDT instruction dated 23.03.2010 and the precedent set by the Supreme Court in Sanjeev Woolen Mills vs. CIT were key references.
Court's Interpretation and Reasoning: The Tribunal examined whether the mark to market loss on derivative instruments could be treated as a deductible expense. It considered the consistent view taken in the assessee's own cases and the principles laid down in Accounting Standard 30.
Key Evidence and Findings: The assessee's transactions were genuine, and the mark to market losses were accounted for following recognized accounting standards. The CIT(A) had previously allowed similar claims in related cases within the same group.
Application of Law to Facts: The Tribunal found that the mark to market losses were not merely notional but were actual losses recognized as per accounting standards, thus deductible.
Treatment of Competing Arguments: The Revenue's argument that these losses were contingent liabilities was not upheld, as the Tribunal emphasized the accounting treatment and previous consistent rulings.
Conclusions: The Tribunal concluded that the mark to market losses on derivative instruments were allowable as deductions, aligning with previous decisions and accounting standards.

Issue 2: Disallowance of Expenses Related to Exempt Income

Relevant Legal Framework and Precedents: The issue revolves around Section 14A of the Income Tax Act and Rule 8D, which specify the disallowance of expenses related to exempt income.
Court's Interpretation and Reasoning: The Tribunal considered whether the CIT(A) correctly deleted the disallowance of interest expenses, given the assessee's own funds exceeded the investments yielding exempt income.
Key Evidence and Findings: The assessee demonstrated that its own funds were sufficient to cover the investments, thus negating the need for disallowance of interest expenses.
Application of Law to Facts: The Tribunal applied the principle that if an assessee's own funds are more than the investments, disallowance of interest is not justified, as supported by the Bombay High Court's decision in CIT vs. HDFC Bank Ltd.
Treatment of Competing Arguments: The Revenue's argument for disallowance was countered by the assessee's evidence of sufficient own funds, leading to the Tribunal's decision to uphold the CIT(A)'s deletion.
Conclusions: The Tribunal upheld the CIT(A)'s decision to delete the disallowance of interest expenses and partially allowed the Revenue's appeal for statistical purposes concerning administrative expenses.

3. SIGNIFICANT HOLDINGS

Verbatim Quotes of Crucial Legal Reasoning: "In view of the direct decisions on the issue from jurisdictional ITAT, the disallowance of Rs. 12,74,59,362/- made on this account is deleted. This ground of appeal is allowed."
Core Principles Established: The judgment reinforces the principle that mark to market losses on derivative instruments, when accounted for as per recognized standards, are deductible. It also upholds that own funds exceeding investments negate the need for disallowance of interest expenses under Section 14A.
Final Determinations on Each Issue: The Tribunal dismissed the Revenue's appeals on the issue of mark to market losses and upheld the CIT(A)'s deletion of interest disallowance related to exempt income, while allowing partial reconsideration of administrative expenses.

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