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TMI Blog2017 (12) TMI 593X X X X Extracts X X X X X X X X Extracts X X X X ..... e prevailing exchange rate. However, the assessee has failed to prove the basic test provided for categorizing that its forward contracts are in the nature of hedging transactions. Even the lower authorities have failed to appreciate the facts in the right perspective in the light of the arguments of the assessee that its forward contracts cannot be linked to its export bills receivables / payables, but total value of its forward contracts is not more than its exposure to foreign currency in the form of receivables / payables. Therefore, we are of the considered view that the issue needs to be re-examined by the AO in the light of above discussions. Hence, we set aside the issue to the file of the AO and direct him to consider the issue afresh Disallowance of expenditure incurred in relation to exempt income u/s 14A r.w.r. 8D(2)(i) and 8D2)(iii) - Held that:- The assessee failed to bring on record any evidence to controvert the finding of the lower authorities. Though the Ld.AR contended that the AO has not established link between expenditure incurred by the assessee to earn exempt income, failed to prove that the assessee has not incurred any expenditure in the backdrop of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to time and furnished the details, as called for. The assessment was completed u/s 143(3) on 29-12-2012 determining the total income at ₹ 28,27,65,840 interalia making disallowances u/s 14A, disallowance of interest u/s 36(1)(iii) and disallowance of speculation loss. Aggrieved by the assessment order, the assessee preferred appeal before CIT(A). 3. The CIT(A), for the detailed reasons recorded in his order dated 17-11- 2011, partly allowed appeal filed by the assessee wherein he restricted disallowance of expenditure incurred in relation to exempt income u/s 14A r.w.r. 8D of ₹ 29,82,050 out of total disallowance worked out by the AO at ₹ 31,91,936. Insofar as disallowance of loss incurred on foreign exchange, the CIT(A) confirmed disallowance made by the AO by holding that the loss incurred by the assessee on account of forward contracts is in the nature of speculative transactions covered u/s 43(5) of the Income-tax Act, 1961. Aggrieved by the order of CIT(A), the assessee is in appeal before us. 4. The first issue that came up for our consideration is disallowance of exchange fluctuation loss on forward contracts. The factual matrix of the case which lead ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee further submitted that its forward contracts are entered into to hedge the currency risk associated with the normal business transactions. These derivative contracts are entered into within the framework of relevant RBI guidelines including quantum limits set by RBI. The intent of entering into derivative contracts was to safeguard interest against exchange rate fluctuation risk on foreign currency receivable / payable and not to carry on separate business activity in dealing with currency. The assessee further submitted that these transactions are directly linked to normal business activity and have direct and proximate nexus to the business of the assessee. Though it is difficult to make one to one co-relation between forward contracts and its export receivable / payable, the total value of forward contracts entered during the period does not exceed its exposure in foreign currency in the form of export receivables / export payables and other foreign currency transactions in the form of loans, etc. Therefore, it has rightly treated loss incurred on forward contracts as its business loss. In support of its arguments, the assessee relied upon plethora of decisions includi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee are clearly in the nature of speculative transactions, therefore, loss on such forward contracts cannot be allowed as deduction; accordingly the AO disallowed exchange loss and added back to the total income of the assessee. 6. The Ld.AR for the assessee submitted that the Ld.AO, on a mistaken fact that loss incurred by the assessee on account of forward contracts represent loss in respect of cancellation of forward contracts and being speculative in nature is not allowable as per the provisions of section 43(5) of the Act. But in reality, this loss is on account of outstanding forward contracts (marked to market) at the year end in accordance with method of accounting regularly followed by the assessee, as per Accounting Standard 11 issued by Institute of Chartered Accountants of India (ICAI). The Ld.AR further submitted that the assessee has entered into forward contracts to hedge its export receivables / payables to mitigate possible loss on account of fluctuation in foreign currency which are in the nature of hedging transactions, therefore, the AO was erred in treating the forward contracts as speculative transactions u/s 43(5) of the Act. The Ld.AR referring to th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... parties, perused the materials available on record and gone through the orders of authorities below. The AO disallowed exchange loss incurred by the assessee on forward contracts on the ground that the forward contracts are in the nature of speculative transactions covered by provisions of section 43(5) of the Income-tax Act, 1961. The AO further observed that the assessee is not able to link one to one co-relation between forward contracts and export bills receivables / payables. According to the AO, a loss incurred on unmatured outstanding forward contracts at the end of the financial year is a notional loss which is marked to market as per the prevailing exchange rate as on the valuation date which is a contingent liability but not an ascertained liability and hence, cannot be allowed as deduction. The AO further observed that the assessee is carrying out speculative transactions by entering into forward contracts in organized and systematic manner. It was further observed that in order to characterize a particular transaction under hedging, it should be linked to bills receivables or payables in respect of its export business. The AO has extensively discussed provisions of sect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5). The assessee claims that loss incurred on maturity / closure of forward contracts has been treated as crystallized liability and debited to the P L Account. Loss incurred in respect of contracts outstanding at the year end has been marked to market based on the prevailing exchange rate in accordance with the method of accounting regularly followed in its business as per AS-11 issued by ICAI. The assessee further contended that it is following this method of accounting consistently for the past several years. The assessee further contended that it is not the case of the AO that only loss incurred on forward contracts has been treated as business los,s but even gain on forward contracts has been treated as business profits. The AO conveniently ignored the gain on forward contracts and has disallowed loss incurred on forward contracts on the ground that these are in the nature of speculative transactions as defined in section 43(5). 10. The provisions of section 43(5) deals with speculative transactions. As per section 43(5), speculative transaction means a transaction in which a contract for the purchase / sale of any commodity including stock and shares is periodically or u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ontracts, its export receivables / payables to contend that at any point of time, its exposure to foreign currency is more than value of forward contracts entered into during the relevant period, the fact remains that the assessee is not able to file one to one co-relation between its forward contracts and export receivables / payables. Since the AO as well as the CIT(A) have not considered the claim of the assessee that its exposure to foreign currency is more than the value of its forward contracts. It is also an admitted fact that the assessee s case is not covered by the exception provided u/s 43(5)(d) of the Income-tax Act, 1961. The sub clause (d) of section 43(5) deals with cases of derivative transactions carried out in the recognized stock exchange. In this case, it is an undisputed fact that the assessee has not carried out its forward contracts through recognized stock exchange. The assessee has entered into forward contracts with its bankers. Therefore, to ascertain forward contracts entered into by the assessee are hedging transactions or speculative transactions, forward contracts have to clear the basic test provided for examining the nature of transactions of hedgin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and 2008-09. 14. The next issue that came up for our consideration is disallowance of expenditure incurred in relation to exempt income u/s 14A r.w.r. 8D(2)(i) and 8D2)(iii) of I.T. Rules, 1962. During the course of assessment proceedings, the AO noticed that the assessee has earned dividend income of ₹ 1,60,00,000 from group companies which has been claimed as exempt u/s 10(34). The AO further observed that the assessee has made investment in group companies at ₹ 5,96,41,000. As per the financial statements, the assessee has taken secured loans of ₹ 469.30 crores and has paid interest of ₹ 44 crores. Therefore, issued a show cause notice and asked as to why expenditure incurred in relation to exempt income shall not be disallowed u/s 14A r.w.r. 8d(2)(i) and (iii). In response to notice, the assessee, vide its letter dated 23- 12-2-2010 has stated that no direct expenditure has been incurred on earning exempt income. The assessee further stated that no specific borrowings were made for making investments and that no interest expense has been directly attributable to any particular income or receipt. The AO, after considering the explanations of the asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ation to exempt income, the possibility of expenditure in the form of general administration and other expenses cannot be ruled out. Since the assessee has not furnished any details with regard to expenditure incurred in relation to exempt income, the AO was right in application of reasonable method in determining disallowances having regard to all the facts and circumstances of the case. With these observations, he restricted the disallowance to 5% of the investment made in shares and worked out disallowance of ₹ 29,82,050 as against disallowance worked out by the AO at ₹ 31,99,936. 16. Facts remain unchanged. The assessee failed to bring on record any evidence to controvert the finding of the lower authorities. Though the Ld.AR contended that the AO has not established link between expenditure incurred by the assessee to earn exempt income, failed to prove that the assessee has not incurred any expenditure in the backdrop of the clear findings of the AO as well as the CIT(A) that the assessee has paid huge interest on borrowings and also incurred common expenditure like general administration and other expenses. Therefore, we are of the view that the CIT(A) was rig ..... X X X X Extracts X X X X X X X X Extracts X X X X
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