Adani Petronet (Dahej) Port Pvt. Ltd Vs DCIT (ITAT Ahmedabad)
Held that M2M loss on SWAP contract was allowable where loans were converted into foreign currency loan to take benefit of low interest rate and loss recognized on account of foreign exchange fluctuation as per notified Accounting Standard 11 was an accrued and subsisting liability and not merely a contingent or hypothetical liability.
Facts- The assessee, is a company which is engaged in the business of development, operation and maintenance of a solid cargo terminal at Dahej. The ROI filed declaring a loss of (-) Rs.94,55,91,217/- which was subsequently revised to (-) Rs.94,24,26,666/-. AO noticed that the assessee has continued to invest Rs.10 crores, the income of which were exempt from tax. No disallowance on account of expenses incurred about the investment was offered by the assessee as required by the provisions of Section 14A of the Act read with Rule 8D. AO made disallowance of Rs.29,03,478/- u/s 14A of the Act on account of expenses incurred about the investment of Rs.10 crores by applying Rule 8D.
The disallowance was challenged by the assessee in an appeal before CIT(A). CIT(A) deleted the said disallowance. Revenue preferred the appeal before Tribunal on the following ground –
1. Deletion of disallowance u/s 14A read with rule 8D;
2. Deletion of addition u/s 14 while computing book profit of the assessee u/s 115JB;
3. Deletion of addition on account of Mark to Market Exchange loss on Foreign exchange derivatives.
Conclusion- It is observed that no income exempt under tax was actually earned by the assessee during the year under consideration and there was thus no exemption claimed by the assessee in respect of any income in the return of income filed for the year under consideration. This being the undisputed position, we find that this issue is squarely covered in favour of the assessee by the decision of Hon’ble Gujarat High Court in the case of Corrtech Energy Pvt. Ltd. (supra) wherein it was held that no disallowance under Section 14A of the Act could be made when no exemption in respect of any income was actually claimed by the assessee. The learned CIT(A), in our opinion, was fully justified in deleting the disallowance made by the Assessing Officer under Section 14A r.w. Rule 8D.
Held that as submitted by the assessee the book profit u/s 115JB of the Act as computed by the AO being negative, the MAT provision was held to be not applicable in the case of the assessee for the year under consideration. This ground raised by the Revenue thus is infructuous.
The issue under consideration is squarely covered in favour of the assessee, in addition to the judicial pronouncements referred to and relied upon by the learned CIT(A) in his impugned order, by the latest decision of the Coordinate Bench of this Tribunal rendered in other group case of M/s. Adani Hazira Port Pvt. Ltd, vide its order dated 06.04.2022 in ITA No.1131/Ahd/2019, wherein it is held that M2M loss on SWAP contract was allowable where loans were converted into foreign currency loan to take benefit of low interest rate and loss recognized on account of foreign exchange fluctuation as per notified Accounting Standard 11 was an accrued and subsisting liability and not merely a contingent or hypothetical liability.
FULL TEXT OF THE ORDER OF ITAT AHMEDABAD
ITA Nos. 1398/Ahd/2018 and 1470/Ahd/2018 are cross appeals filed by the assessee and Revenue respectively against the order of the learned CIT(A)-1, Ahmedabad dated 28.03.2018 for Assessment Year 2012-13. ITA Nos. 1792/Ahd/2018 & 2045/Ahd/2018 are the appeals filed by the Revenue and CO Nos. 89/Ahd/2019 & 88/Ahd/2019 are the cross-objections thereof filed by the assessee against the separate orders of the learned CIT(A)-5, Ahmedabad dated 30.05.2018 and CIT(A)-1, Ahmedabad dated 26.07.2018 for Assessment Years 2013-14 and 2014-15 respectively. Since these appeals/COs involve common issues, the same have been heard together and are being disposed of by a single consolidated order for the sake of convenience.
2. First we take up the Revenue’s appeal for AY 2012-13 being ITA No.1470/Ahd/2018 which is directed against the order of learned CIT(A)-1, Ahmedabad dated 28.03.2018.
3. The issue raised in ground No.1 of this appeal relates to the deletion by the learned CIT(A) of the addition of Rs.29,03,478/- made by the Assessing Officer on account of disallowance under Section 14A of the Income-tax Act, 1961 (“the Act” in short) read with Rule 8D of Income-tax Rules, 1962 (“Rule” in short).
4. The assessee, in the present case, is a company which is engaged in the business of development, operation and maintenance of solid cargo terminal at Dahej. The return of income for the year under consideration was originally filed by the assessee on 29.09.2012 declaring a loss of (-) Rs.94,55,91,217/- which was subsequently revised to (-) Rs.94,24,26,666/- in the return filed on 27.09.2013. The return filed by the assessee was selected for scrutiny and during the course of assessment proceedings, it was noticed by the Assessing Officer that the assessee has continued to make an investment of Rs.10 crores in the year under consideration, the income of which was exempt from tax. No disallowance on account of expenses incurred in relation to the said investment, however, was offered by the assessee as required by the provisions of Section 14A of the Act read with Rule 8D. In this regard, the explanation offered by the assessee that there being no exempt income actually earned during the year under consideration on the investment in question, the disallowance under Section 14A of the Act is not warranted was not found acceptable by the Assessing Officer and by relying inter alia on the decision of the Delhi Special Bench of ITAT in the case of Cheminvest Ltd vs. ITO (ITA No. 87/Del/2008) as well as CBDT Circular No.5/2014 dated 11.02.2014, he proceeded to make a disallowance of Rs.29,03,478/- under Section 14A of the Act on account of expenses incurred in relation to the investment of Rs.10 crores by applying Rule 8D.
5. The disallowance of Rs.29,03,478/- made by the Assessing Officer under Section 14A r.w. Rule 8D was challenged by the assessee in an appeal filed before the learned CIT(A) and after considering the submissions made on behalf of the assessee as well as the material available on record, the learned CIT(A) deleted the said disallowance by relying inter alia on the decision of Hon’ble Gujarat High Court in the case of CIT vs. Corrtech Energy Pvt. Ltd., reported in (2014) 272 CTR 262 (Guj.), wherein it was held that no disallowance could be made under Section 14A of the Act where the assessee had not made any claim for exemption of any income.
6. We have heard the arguments of both the sides on this issue and also perused the relevant material available on record. It is observed that no income exempt under tax was actually earned by the assessee during the year under consideration and there was thus no exemption claimed by the assessee in respect of any income in the return of income filed for the year under consideration. This being the undisputed position, we find that this issue is squarely covered in favour of the assessee by the decision of Hon’ble Gujarat High Court in the case of Corrtech Energy Pvt. Ltd. (supra) wherein it was held that no disallowance under Section 14A of the Act could be made when no exemption in respect of any income was actually claimed by the assessee. The learned CIT(A), in our opinion, was fully justified in deleting the disallowance made by the Assessing Officer under Section 14A r.w. Rule 8D by relying on the decision of Hon’ble jurisdictional High Court in the case of Corrtech Energy Pvt. Ltd. (supra) and upholding his impugned order giving relief to the assessee on this issue, we dismiss Ground No.1 of the Revenue’s appeal.
7. As regards the issue involved in Ground No.2 of the Revenue’s appeal relating to the deletion by the learned CIT(A) of the addition of Rs.29,03,478/- made by the Assessing Officer on account of disallowance under Section 14A while computing the book profit of the assessee-company under Section 115JB of the Act, the learned Counsel for the assessee has pointed out that the book profit under Section 115JB of the Act as computed by the Assessing Officer being negative, the MAT provision was held to be not applicable in the case of the assessee for the year under consideration. This ground raised by the Revenue thus is infructuous and even the learned DR has not disputed this position. The same is accordingly dismissed as infructuous.
8. In Ground No.3, the Revenue has challenged the action of the learned CIT(A) in deleting the addition of Rs.32,50,27,494/- made by the Assessing Officer on account of Mark to Market Exchange Loss on Foreign Exchange Derivatives.
8.1 In the Profit & Loss account filed along with the return of income, a sum of Rs.32,50,27,494/- was debited by the assessee being loss on account of derivative transactions for conversion of foreign currency loan on port. During the course of assessment proceedings, the assessee-company was called upon by the Assessing Officer to explain the nature of the said Mark-to-Market Exchange Losses and to furnish the relevant details relating to loss on derivatives / swap contracts. In reply, the following submission was made by the assessee:-
“1.1 In this regard, we would like to submit that the assessee has taken a rupee term loan of Rs. 500 Crores with an effective rate of interest @ 11.75% as is clearly evident from Schedule-5, “Long Term Borrowing” of Financial statements. We are herewith attaching a copy of sanction letter dated 12.07.2010 enclosed herewith vide Annexure-1. With a view to reduce the rate of interest on the said rupee term loan, the assessee company entered into Principal Only Swap (POS) contract with ICICI Bank Ltd and Axis Bank Ltd to convert the said Rupee Term Loan into Dollar Loan as per the copy of contract entered into with those banks. The sample copies of the contracts/deal confirmation are attached herewith vide Annexure-2.
1.2 By entering into this swap transaction, the assessee company has reduced its interest liability by Rs. 3,89,91,215 during the current year under assessment as can be seen from ledger account enclosed herewith vide Annexure-3. We are herewith attaching a chart showing the decrease in rate of interest on loan due to this swap deals vide Annexure-4. As is clearly evident from the chart the effective rate of interest has been reduced from 11.75% to 6.67 – 9.85%. Accordingly, it could be noted that a substantial reduction in the rate of interest could be achieved by entering into such swap deals by the assessee company. It is worthwhile to note that the assessee company has entered into swap contracts for the underlying being Indian Rupee denominated loans taken for the purpose of acquiring the fixed assets of the assessee company. The assets for which such loan was taken are already put to use as is evident on perusal Note No 36 of the schedule of CWIP which shows that the entire amount has been capitalized to the respective fixed assets and the interest on the said loans after capitalizing the said assets is debited to the Profit and Loss Account. Further, it is submitted that the said accounting treatment has been followed by the company consistently on year to year basis. It may be appreciated from the chart enclosed herewith vide Annexure-5 that the said kind of transactions are also done in the subsequent years. Your good self will find that the assessee has benefited from the swap transactions as and when the value of rupee increases more particularly in the F.Y. 2014-15. In this regard, AS-1-Disclosure of Accounting Policies issued by ICA! is worth noting, the relevant para of the same is reproduced herein under:
17. For this purpose, the major considerations governing the selection and application of accounting policies are:—
a. Prudence
In view of the uncertainty attached to future events, profits are not anticipated but recognised only when realised though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.
Accordingly, we submit that the assessee company has, in view of principle of conservatism also known as prudence being fundamental factor governing selection of accounting policy, recognised M2M loss as at the end of year on outstanding SWAP contracts to give true and fair view of the financial affairs of the year under consideration.
1.3 Your good self’s attention is invited to Note No 37 of the Audited Financial statements wherein the information regarding INR-foreign currency derivative principal only swap (POS) to hedge loan and interest liabilities is provided. Your good self’s attention is further drawn to Note No 2(i) on significant accounting policy in respect of foreign currency transaction wherein accounting policy on initial recognition, conversion and exchange differences in respect of foreign currency transactions is disclosed. Further, we would like to point out that the said provision for marked to market loss has been made so as to comply with the requirement of Accounting Standard-11 on “the Effects of Changes in Foreign Exchange Rates” and accordingly, your good self’s observation that said marked to market loss is in the nature of notional loss and not a real toss is not correct in view of the decision of Hon’ble Supreme Court of India in the case of CIT Vs Woodward Governor India Pvt Ltd reported in (2009) 312 1TR 254 (SC), the head note of the said decision reads as under-
Section 37(1), read with section 145, of the Income-tax Act, 1961 -Business expenditure – Allowability of – Assessment year 1998-99 – Whether expression ‘expenditure’ as used in section 37 may, in circumstances of a particular case, cover an amount which is really a ‘loss’, even though said amount has not gone out from pocket of assessee – Held, yes – Whether loss suffered by assessee on account of foreign exchange difference as on date of balance sheet is an item of expenditure under sect/on 37(1) – Held, yes – Whether accounting method followed by an assessee continuously for a given period of time needs to be presumed to be correct till Assessing Officer comes to conclusion for reasons to be given that said system does not reflect true and correct profits – Held, yes -Whether an enterprise has to report outstanding liability relating to import of raw material using closing rate of foreign exchange and any difference, loss or gain, arising on conversion of said liability at closing rate should be recognized in profit and loss account for reporting period – Held, yes.”
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1.4 In view of above discussion, it is abundantly clear that the assesses company has recognized marked to market loss on principal only swap transactions with a view to comply with requirement of Accounting Standard 11 to arrive and true and fair commercial profit for the year under consideration. Further, on perusal of details submitted herein above, it is evident that the assessee company has been consistently following the said method of accounting. To put things into perspective, we submit that rate of interest on Rupee terms loans is very high as compared to Foreign currency denominated loan on account lower rate of interest prevailing in globally compared to India. As mentioned in para 1.2 hereinabove, the assessee company has reduced the interest cost by Rs 3.89 Crores in the year under consideration, Rs 8.39 Crores in F.Y.12-13 and Rs 9.74 Crores in F.Y.13-14 as can be seen from perusal of Annexure-4 of this submission and thereby, saved huge amount of money by swapping rupee loans with foreign currency loans. Further, we submit that since, the entire amount of interest expense pertaining to assets which have capitalized is charged to P&L account, marked to market foreign exchange loss on loans taken for said assets is also charged to P&L account as for the assessee company interest cost on foreign currency loan comprises of lower interest expense on foreign currency loan plus foreign exchange fluctuation on said loan. Had the assessee company not converted rupee term loans into foreign currency loan, the P&L account would have been hit by higher interest expenditure. Therefore, we submit that the Swap transaction should not be seen isolation but its impact on interest expenditure i.e. rate of interest plus cost of forex loss/gain should be considered to determine the nature of loss. Additionally, as noted by the Hon’ble Apex Court in Woodward Governor (Supra) discussed herein above, marked to market foreign currency loss is not in the nature of notional loss but a business expenditure u/s 37(1) of the IT Act as the expression expenditure covers an amount which is really a ‘loss’, even though said amount has not gone out from pocket of assessee.
1.5 Accordingly, the assessee company humbly submits that the market to market loss as claimed by the assesse shall be allowed for deduction u/s 37 of the IT Act.”
8.2 The Assessing Officer did not find merit in the submission filed by the assessee for the following reasons given in his order:-
“The assessee in its submission has pointed out that the said losses have been occurred on account of entering into swap contract for the underlying being Indian rupee denominated loans taken for the purpose of acquiring the fixed assets of the assessee company. It has also stated that the assets in respect of which said loans were taken has already been capitalized and the interest on the said loans after capitalizing the said assets debited to the Profit & Loss account The assessee company has also contended that the said provision for marked to market loss has been made so as to comply with the requirement of accounting standard 11. The assessee company has further contended that the said M2M loss is not in the nature of notional loss. The assessee company has relied upon the decision of the Hon’ble Supreme Court in the case of CIT V/s. Woodward Governor India Pvt. Ltd. The above submission of the assessee company has been duly gone through. The contentions of the assessee company are not tenable. It has not explained with supporting evidences whether the loss on account of forex derivatives (M2M toss on currency swap) is on principle amount or interest amount. Therefore, the assessee has not explained the exact nature of said losses. Further, on legal ground also, the claim of the assessee company is not allowable. Under Indian Income tax Act, there is no special provision or treatment for M2M method of accounting. It is governed by general principles of taxation based upon various judicial decisions. Loss or gain arises only when something goes out of one’s pocket or something goes into one’s pocket. There is no actual loss on account of dealing in forex derivatives (currency swap) until their final values are known. Therefore, the assessee’s claim of M2M losses amounting to Rs.32.50 crores is not allowable. Though the assessee is at liberty to report of such notional losses to adhere or comply with the accounting guidelines, however, the same does not make it (M2M losses) deductible for income tax purposes. The provisions of Income tax Act. 1961 do not allow any such deduction of notional loss for which the liability has not crystallized. Therefore, M2M losses on account of revaluation of forex derivative (swap contract) are only notional and cannot be deductible as business losses under Income tax provisions. It is very well for the assessee company to comply with the relevant Accounting Standard to finalize its Balance sheet as on 31/03/2012 and to account for its liability, however, since the assessee has not actually suffered such losses or has not actually paid such liability, and therefore, the losses are remained notional, uncrystallized, and therefore, not allowable and deductible. The assessee has also contended that the said loans were taken for the purpose of acquiring the fixed assets and the M2M losses are thus required to be allowed. The notional losses arisen out on account of interest (or principle) liability as at the end of the year without actual payment may be accounted for in the respective assets as per the provisions of Income tax Act, but the same cannot be claimed in the Profit & Loss account The assessee company may capitalize such losses of gain in the respective assets as per the provision of the Income tax Act, however, the depreciation as per I.T. Act will be allowed only on actual basis. Thus, the amount debited is a notional loss and definitely not an ascertained one. Said losses are contingent in nature as they arise out of the past swap contracts entered into by the assessee-company and whether they will actually occur or not cannot be reliable estimated until the occurrence of future uncertain events which is beyond the control of the assessee-company. As to whether the assessee will incur the loss or not is contingent and unascertainable. Moreover, the important fact based on which the Hon’ble Supreme Court in the case of Woodward Governor decked the issue in favour of the assessee-company was that the department taxed the accrued foreign exchange gains, however, denied the foreign exchange losses as on the balance sheet date.
Further, the assessee has no liability to pay the difference amount arisen out on date of balance sheet. The Instruction No.03/2010 dated 23/03/2010 of CBDT does not allow such notional losses. The assessee company itself has admitted that it has recognized M2M loss on principle only swap transactions with a view to comply with requirement of accounting standard 11, which clearly shows that, it has actually not suffered the said losses.
The assessee has cited AS-11 in his support which advises that all foreign currency monetary transactions are to be reported based on the closing exchange rate at the end of this accounting period. The said standard may be valuable for enforcing prudent disclosure norm. However, it is well settled that a good accounting standard need not be a good law and the former cannot be override the later as it lacks statutory force, unless notified under section 145(2) of the Act. Thus, while the assessee is at liberty to follow it in its books, for Income Tax purposes it ought to have added back the contingent liability to its taxable profit and therefore the notional loss is liable to be disallowed.”
For the reasons given above, the Assessing Officer held that the foreign exchange derivative losses amounting to Rs.32,50,27,494/- claimed by the assessee were notional losses and same could not be allowed as deduction being contingent in nature.
8.3 The disallowance of Rs.32,50,27,494/- made by the Assessing Officer on account of its claim for deduction for Mark-to-Market Exchange Loss in respect of Foreign Exchange Derivatives was challenged by the assessee in an appeal filed before the learned CIT(A) and during the course of appellate proceedings before the learned CIT(A), the assessee in addition to reiterating the submissions made before the Assessing Officer also made the following submissions in writing:-
1. During the course of appellate proceedings your good honor has asked the appellant to submit the details of mark to market losses currency derivative contract. The appellant herein submits that as per the accounting policies of the company provides for mark to market losses arising on Derivatives/Swsp Contracts. Similarly, in the event when the appellant company earns gain on such contracts, the same is offered to tax following the accounting policies on the consistent basis. The appellant herein submits the details of provision made for mark to market loss during the A.Y. 201213, 2013-14 and 2014-15:
