2022 (12) TMI 358 - HC - Income Tax

Foreign exchange fluctuations loss on unmatured, matured and cancelled forward contracts - loss on Forward Cover Purchase Contracts for foreign exchange (hereafter Forward Contracts ) - allowable as a deduction from the income chargeable to tax for the relevant assessment year notwithstanding that the Forward Contracts have not closed - Whether the losses on account of foreign exchange fluctuations on forward contracts are allowable undersection 37(1) of the Income Tax Act and covered as hedging transactions u/s 43(5)(a) of the Act or should be disallowed as speculation losses under Section 43(5) of the Act in view of the CBDT Instruction No. 3/2010 dated 23.03.2010? - HELD THAT - Undisputedly, the Forward Contracts, in the present case, are hedging transactions. Assessee has reinstated its debits and credits from the underlying transactions on the value of the foreign exchange on the due date. The corresponding losses/gains under the Forward Contracts, thus, were also required to be accounted for to arrive at the real profits. It would be anomalous if, on the one hand, debtors and creditors, in respect of current assets, are stated at the current value of foreign exchange and the corresponding loss on the hedging transaction is not accounted for. In essence, the Assessee has stated his income by taking into account the foreign exchange value as it stands on the due date. It is well settled that the CBDT Instructions and circulars which are contrary to law are not binding. This Court finds no fault with the order of the learned CIT(A) as well as the learned Tribunal in finding that the loss, on account of Forward Contracts, cannot be considered as speculative and the AO had erred in disallowing the same. The questions raised (Questions I and II) are thus, covered by the decision of the Supreme Court in CIT v. Woodword Governor India Pvt. Ltd. 2009 (4) TMI 4 - SUPREME COURT . Disallowance u/s 14 A - determine the expenditure attributable to earning dividend income at 0.5% of the value of average investment in terms of Rule 8D of the Rules - HELD THAT - It is not disputed that the AO can ascertain the expenditure attributable to earning tax-free income if he is not satisfied that the Assessee s allocation of expenses for earning the said income or otherwise and or is otherwise dissatisfied with the Assessee s explanation. A plain reading of the impugned order passed by Tribunal indicates that the Tribunal also did not find, as a matter of fact, that the Assessee had devoted any of its resources for managing the said investments or had otherwise incurred any expenditure for the same. It is relevant to note that the Assessee s assertion, that its investment was monitored by a group of company without levying any charge or fee, was not found to be incorrect. Tribunal did not accept the AO s determination of ₹8,53,916/- as expenditure incurred for earning the exempt income. Notwithstanding the above, the learned Tribunal held that the deployment of manpower for monitoring the dividends from mutual funds cannot be ruled out. On this basis the learned Tribunal had reduced the disallowance from ₹8,53,916/- to ₹1,00,000/-per month on ad-hoc basis. As submitted on behalf of the Revenue that reduction on ad-hoc basis is not permissible. We are of the view that once the Revenue Authorities have found no reason to doubt the Assessee s claim that the investments have been managed by a group company without levy of charge, it may not be open for the tribunal to disallow expenditure on the basis that some deployment of manpower for managing the investment cannot be ruled out . Assessee has not appealed against the said decision. As noted above, the present appeal has been filed against the impugned order passed whereby the learned Tribunal had dismissed the appellant s appeal. The Revenue s appeal before learned Tribunal was confined to disallowance of loss on account of Forward Contracts.

Summary

Issues Involved:
1. Allowability of foreign exchange fluctuations loss on unmatured, matured, and canceled forward contracts.
2. Classification of losses on forward contracts as hedging transactions under Section 43(5)(a) or as speculation losses under Section 43(5) of the Income Tax Act in view of CBDT Instruction No. 3/2010.
3. Determination of disallowance under Section 14A of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Allowability of Foreign Exchange Fluctuations Loss:
The primary issue in the appeal was whether the loss on Forward Cover Purchase Contracts for foreign exchange (Forward Contracts) is allowable as a deduction from the income chargeable to tax for the relevant assessment year, even if the Forward Contracts have not matured. The Assessee engaged in engineering consultancy and related services entered into Forward Contracts to hedge against foreign exchange fluctuations. The Assessing Officer (AO) disallowed the loss on these contracts, treating it as speculative based on CBDT Instruction no.3/2010, which requires 'Marked to Market' losses to be added back for computing taxable income. However, the Commissioner of Income Tax (Appeals) [CIT(A)] and the Income Tax Appellate Tribunal (ITAT) found that the Forward Contracts were for hedging against foreign exchange fluctuations related to business transactions and not speculative. The Tribunal held that the loss on Forward Contracts is allowable under Section 37(1) and covered as hedging transactions under Section 43(5)(a), referencing the Supreme Court decision in CIT v. Woodword Governor India Pvt. Ltd. The High Court upheld this view, stating that the Forward Contracts were integral to the business transactions and the loss should be recognized to ascertain the correct taxable profits.

2. Classification of Losses on Forward Contracts:
The Revenue contended that the losses on Forward Contracts should be disallowed as speculative losses under Section 43(5) in view of CBDT Instruction No. 3/2010. However, the High Court found that the Forward Contracts were entered into to hedge against foreign exchange fluctuations arising from business transactions and were not speculative. The Court noted that the Assessee consistently followed the accounting system and the transactions fell within the exceptions of proviso (a) to Section 43(5). The Court concluded that the loss on Forward Contracts could not be considered speculative and was allowable as a business loss, aligning with the Supreme Court's decision in CIT v. Woodword Governor India Pvt. Ltd.

3. Disallowance under Section 14A:
Although this issue was not part of the Revenue's appeal, it was discussed as part of the Assessee's appeal before the Tribunal. The AO had disallowed Rs. 8,53,916 under Section 14A, attributing it to expenditure for earning dividend income from mutual funds. The Assessee claimed no expenditure was incurred for earning the dividend income, as the investments were managed by a group company without charges. The Tribunal reduced the disallowance to Rs. 1,00,000 on an ad-hoc basis, acknowledging that some manpower deployment for monitoring dividends could not be ruled out. The High Court noted that the AO had not found any material facts to dispute the Assessee's claim and that the Tribunal's ad-hoc reduction was not permissible. However, since the Assessee did not appeal against this decision, the High Court did not provide further relief on this issue.

Conclusion:
The High Court found no substantial question of law arising from the Revenue's appeal and upheld the decisions of the CIT(A) and the Tribunal, dismissing the appeal. The Court confirmed that the loss on Forward Contracts was allowable as a business loss and not speculative, and the disallowance under Section 14A was not a subject matter of the Revenue's appeal.