2019 (2) TMI 1532 - AT - Income Tax

Allowability of claim of bad debt u/s 36(1)(vii) - Conditions specified u/s 36(2) - Bad debt has been written off as irrecoverable in its books of accounts - loss on derivative transaction on the spot market - provisions of Section 45V of RBI Act - Whether derivative transactions and loss arising therefrom is in the nature of speculative loss which cannot be allowed set off against normal business income - HELD THAT - conceptually, the derivative transactions are not delivery based but are based on future prices, however the transaction on the spot market are delivery based having certainty of their values. However, question that arises for consideration is whether in the instant case, the transaction of purchase and sell of commodities are delivery based or not and a related issue of whether they are speculative transaction or not. Both the issues are closely linked and connected, and needs to be examined thoroughly to determine the exact nature of the transaction and treatment thereof for tax purposes. Once it is decided that the transactions are delivery based and thus not speculative in nature, the question of allowability of claim of bad debt under section 36(1)(vii) will arise for consideration. Merely stating that the VAT charges have been levied as per contract notes would not make the transaction as that of sale and delivery unless the transaction is demonstrated by actual stock of commodity and transfer through delivery. Once it is determined that there was actual stock of requisite quantity which has been contracted to be purchased and sold and the delivery thereof has happened, the transaction would be considered as delivery based transaction and not a speculative transaction. The allowability of claim under section 36(1)(vii) will arise for consideration and need to be reconsidered by the AO in light of legal proposition so laid down by the various Courts, so relied upon by the AR, wherein it has been held that when the assessee treats the debt as a bad debt in his books, the decision has to be a business or commercial decision and not whimsical or fanciful. The decision must be based on material that the debt is not recoverable and the decision must be bona fide. The assessee company has to show that bad debt has been written off as irrecoverable in its books of accounts and conditions specified u/s 36(2) have been satisfied. The allowability of claim u/s 36(1)(vii) will need to be reconsidered by the AO including on the point of satisfaction of conditions specified u/s 36(2). We are setting aside the matter to the file of the AO to examine the matter afresh in light of above directions after providing reasonable opportunity to the assessee. - Remanded back - Decided in favour of revenue for statistical purposes. Disallowance u/s 14A - HELD THAT - The investments in subsidiary companies have been made out of fresh capital raised during the year and further, there has been no dividend income in respect of investment in subsidiary during the year and hence, the said investment will not form part of disallowance under section 14A read with Rule 8D. In respect of fresh investments under PTC amounting to ₹ 17.07 Crores during the year, the assessee company has sufficient interest free funds and it has been stated that tax has already been paid by the assessee company. In light of the same, following the order of the Coordinate Benches in the earlier year, the AO was not justified in making disallowance u/s 14A of the Act r.w. Rule 8D - Decided against revenue.

Summary

Issues Involved:
1. Deletion of addition of ?10,62,00,000/- by CIT(A) regarding transactions on National Spot Exchange Limited (NSEL).
2. Validity of transactions under Section 45V of the RBI Act.
3. Disallowance under Section 14A read with Rule 8D of the Income Tax Act.

Detailed Analysis:

1. Deletion of Addition of ?10,62,00,000/- by CIT(A) Regarding Transactions on NSEL:

The Revenue challenged the deletion of ?10.62 Crores by CIT(A), arguing that the transactions were derivative transactions and not spot transactions. The Assessing Officer (AO) had disallowed the claim of bad debts by the assessee, citing that the recovery process was ongoing and the transactions were not related to the business activities permitted by the RBI. The AO also noted that NBFC companies are restricted from trading in derivative contracts unless the counterparty is a bank, making the transactions illegal and contrary to public policy under Section 37(1) of the Act.

The CIT(A) found that the transactions were spot transactions involving actual delivery of commodities, thus not speculative in nature. The CIT(A) held that the transactions were regular business activities and the losses incurred due to the NSEL scam were trading losses, qualifying as bad debts under Section 36(1)(vii) of the Act.

The Tribunal agreed with CIT(A) that spot transactions involve actual delivery and are different from derivative transactions. However, it emphasized the need for verifiable evidence to support the claim of actual delivery of commodities. The Tribunal set aside the matter to the AO for a fresh examination to determine whether the transactions were delivery-based and thus not speculative. The AO was directed to reconsider the allowability of the bad debt claim under Section 36(1)(vii) after verifying the facts.

2. Validity of Transactions Under Section 45V of the RBI Act:

The Revenue argued that the transactions violated Section 45V of the RBI Act, which restricts NBFCs from trading in derivative contracts unless the counterparty is a bank. The CIT(A) examined the nature of the transactions and concluded that they were spot transactions, not derivative transactions. The Tribunal upheld this view, noting that spot transactions are delivery-based and not speculative. It directed the AO to verify the actual delivery of commodities to confirm the nature of the transactions.

3. Disallowance Under Section 14A Read with Rule 8D of the Income Tax Act:

The AO disallowed ?72,25,530 under Section 14A read with Rule 8D, arguing that the assessee earned exempt income from investments. The CIT(A) noted that the assessee had sufficient interest-free funds to cover the investments and had already disallowed ?49,095 suo moto. The CIT(A) referred to various judicial pronouncements, including the Supreme Court's decision in Maxopp Investment Ltd. vs. CIT, emphasizing the need for the AO to record satisfaction that the assessee's disallowance was incorrect before invoking Rule 8D.

The Tribunal agreed with CIT(A) that the AO failed to establish a nexus between borrowed funds and the investments. It also noted that the investments in subsidiary companies did not yield any dividend income during the year, and the assessee had sufficient interest-free funds. The Tribunal upheld the deletion of the disallowance under Section 14A read with Rule 8D.

Conclusion:

The appeal by the Revenue was partly allowed for statistical purposes. The Tribunal directed the AO to re-examine the nature of the transactions on NSEL and reconsider the bad debt claim under Section 36(1)(vii) after verifying the facts. The disallowance under Section 14A read with Rule 8D was deleted, supporting the CIT(A)'s findings that the assessee had sufficient interest-free funds and the investments did not yield exempt income during the year.