Forex derivative transaction for hedging the foreign currency risk is not speculative transaction

Oswal Woollen Mills Ltd. Vs Addl. CIT (ITAT Chandigarh)

Held that the assessee entered into forex derivative transaction with the ICICI Bank to hedge the foreign currency risk involved in the transaction. Thus, expenses claimed were revenue in nature as the derivative transaction entered into by the assesse was not in the nature of speculative transaction.

Facts-

The grievance of the assessee relates to the sustenance of addition of Rs. 13,32,96,175/- made by the AO on account of foreign exchange hedging loss incurred during the course of regular business by treating the same as speculative transaction.

Conclusion-

Held that the assesse during the course of its regular business entered into derivative contract for the purpose of hedging its business loss arising out of exchange fluctuation in its day to day business activity and there was no element of speculation involved. The assessee entered into forward contract with the ICICI Bank to hedge the import payments and repayments of the loans therefore the transaction entered into by the assessee was not speculative transaction.

FULL TEXT OF THE ORDER OF ITAT CHANDIGARH

These Cross Appeals by the different Assesses and Department are directed against the separate order each dated 18/12/2014 of the Ld. CIT(A)-3, Ludhiana.

2. Since the issues involved are common and the appeals were heard together, so these are being disposed off by this consolidated order for the sake of convenience and brevity.

3. At the first instance, we will deal with the appeal in ITA No. 153/Chd/2015 relating to M/s Oswal Woolen Mills Ltd. for the A.Y. 2011-12.

4. Following grounds have been raised by the assessee in this appeal:

1. That the worthy CIT(A)-3, Ludhiana erred in law and on facts in upholding the addition of Rs. 13,32,96,175/- being the amount of foreign exchange hedging loss incurred during the course of appellant’s regular business by treating the same as speculative transaction. Direction may be given to allow the said loss as business loss.

Without prejudice and in alternative, directions be given to Assessing Officer to carry forward the unabsorbed loss of this year under derivative transactions to the subsequent year.

2. a. That the worthy CIT(A)-3, Ludhiana erred in law and on facts in upholding the disallowance of Rs. 1,32,24,640/- u/s 14A of the Act made by the Assessing officer by applying rule 8D of the Income Tax Act , and in view of the fact that appellant itself disallowed Rs. 66,419/- in its return on proportionate basis. Directions may be given not to apply rule 8D in the case of appellant company when the appellant itself disallowed expenditure of Rs.66,419/- in its return on the basis and method recognized by courts on proportion basis and the same be restricted to the amount as shown shown in the return.

b. That the worthy CIT(A)-3, Ludhiana, further erred in law and on facts in upholding the order of the Assessing officer ,that the amount of interest paid on term loans and on working capital loans amounting to Rs 9,72,96,717/- & Rs.3,46,88,240/- respectively as well as bank charges of Rs. 97,27,105/-, be considered while computing disallowance u/s 14 A read with Rule 8 D . Directions be given to exclude the amount of interest paid on term loans as well as interest on working capital loans and bank charges, while computing the disallowance u/s 14 A by applying Rule 8D as the said loans were obtained and utilised for specific business purposes.

c. That the worthy C.I.T(A) further erred in law and on facts in upholding the method of calculating disallowance u/s 14A read with rule 8D, by considering the average total investments, which is totally wrong and against the spirit of section 14A of the act.

Directions be given to consider only the average of total investments on which the dividend income i.e. Exempt income was received during the year instead of the average total investments of the company.

3. That the worthy CIT(A)-3, Ludhiana erred in law and on facts in upholding the disallowance of Rs. 1,53,17,042/-out of interest paid on working capital loan and long term loan, on the presumption that the assessee might have utilized borrowed funds for investment in shares. Disallowances made on assumption, surmises and conjectures may be directed to be deleted.

Directions may be given to allow interest paid on the moneys borrowed for the business purposes and also utilized for the said purpose only

Without prejudice to the above the Ld. C.I.T (A) – 3, Ldh, further erred in law and facts in not giving the directions to rightly compute the disallowance u/s 36(i)(iii), even based on debt equity ratio, which comes to Rs. 1,39,62,158/- instead of Rs. 1,53,17,042/- calculated by the assessing officer.

4. That the worthy CIT(A)-3, Ludhiana erred in law and on facts in not deleting the whole addition of Rs.2632429/- made by assessing officer under proviso to section 36(i)(iii) on account of borrowed amount utilized from mixed funds from C.C A/c for purchase of fixed assets.

Directions be given to delete the total addition sustained by worthy CIT (A) -3 made out of interest paid to bank on C.C. A/c for working capital which was actually utilized for the said specific purpose..

5. That the appellant craves, leave to add, amend, alter, modify or substitute all or any of the above mentioned Ground of appeal before the appeal is finally heard and disposed off.

5. Vide Ground No. 1 the grievance of the assessee relates to the sustenance of addition of Rs. 13,32,96,175/- made by the AO on account of foreign exchange hedging loss incurred during the course of regular business by treating the same as speculative transaction.

6. The facts relating to this issue in brief are that the assessee was engaged in the manufacturing and export of cotton /blended yarn and manufacturing of hosiery garments. The assessee also had a wholly owned subsidiary i.e; M/s Monte Carlo Fashions Limited and manufactured various types of worsted yarn, textile fabric, woolen hosiery, denim fabric and readymade garments through the process of combing, spinning, knitting and weaving. Apart from manufacturing the assessee company was also doing investment in quoted and unquoted scripts. The assessee filed its return of income on 28/09/2011 declaring an income of Rs. 123,32,61,214/-, later on the case was selected for scrutiny.

6.1 During the course of assessment proceedings the AO noticed that the assessee had claimed deduction of Rs. 13,32,96,175/- in the P&L account and computation of income on account of difference in foreign exchange rates. The assessee had debited a sum of Rs. 79,09,196/- to its P&L Account which had been arrived at by deducting the amount transferred from foreign exchange contingent (diputed) liability reserve amounting to Rs. 12,53,86,979/- from difference in foreign exchange rate of Rs. 13,32,96,175/-. The AO also observed that the assessee in the computation of income had claimed deduction of Rs. 12,53,86,979/- as amount transferred from reserve. Thus the assessee had claimed over all deduction of Rs. 13,32,96,175/- to the P&L Account and computation of income on account of difference in foreign exchange rate. The AO asked the assesee vide point no. 20 of notice under section 142(1) of the Income Tax Act, 1961 (hereinafter referred to as ‘Act’)to furnish the details in respect of foreign exchange rate by stating as under:

‘Provide the details of foreign exchange transaction in the following manner:-

(a) Total number of foreign exchange forward contracts entered by the company during the year.

(b) How the foreign currency liabilities incurred were adjusted at contracted rates and at prevailing exchange rates? What was the method to determine the same? Produce documentary evidence in support of your reply.

(c) Provide the details of variation arising in conversions which were adjusted to the cost of fixed assets. Provide the details asset-wise. Do not provide the cumulative figures. Details should be comprehensive and in the form of a chart.

(d) Details of short term foreign currency loans raised, amount of premium paid on such loans and method of calculation of premium on pro-rata basis. Also provide the details of the amounts charged to revenue account, asset wise, in the form of a chart. Produce documentary evidence in support of your claims.”

6.2 In response the assessee submitted as under:

“The complete detail of foreign exchange difference of Rs, 4.25 Crore is enclosed as annexure – 4. The net amount of foreign exchange difference pertains to booking of foreign currency in the course of its regular business. The Company booked foreign exchange against import commitments and export obligations. This is a necessary business expenditure and may be allowed. The company has not followed AS-1 1, had the company followed the accounting standard with regard to foreign exchange rates, the net profit before Tax would have been lower by Rs. 49 Lacs approx. This has been clarified in notes on accounts at item No. C(iv) on page 24 of the Printed Balance Sheet. The-company has been adjusting foreign currency exchange rate difference to the fixed assets which pertains to the purchase of fixed assets.”

6.3 The AO again asked the assessee vide notice under section 142(1) of the Act dated 18/12/2013, the following questions:

’11. From the computation of income is has been observed that an amount of Rs. 12,53,86,979/- has been reduced from the total income. Please justify the deduction. Also submit a detailed note regarding the nature of the amount as well as the reason for deduction.

18. Detailed note on foreign exchange contingent (disputed liability reserve).

34. It has been observed from note B(vii) that an amount of Rs. 12,58,87,000 has been provided as expense in the books of accounts on account of derivative contracts. Please justify its deduction.”

6.4 In response the assessee replied as under:

Reply to this query has already been given vide our letter dated 27/1/2014, However the copies of ISDA agreement along .with the copies of contracts are enclosed as Annexure-2. As desired the copy of MOU/Settlement agreement with the bank for the final liability on account of foreign exchange transaction are enclosed as Ann exure-4 along with Mark to Market valuation. Since the net claim of Rs. 13.33 Cr. debited in the books is directly relatable to the business which has crystallized and finally ascertained during the year, therefore, the same may be allowed as claimed in the return.”

6.5 The AO mentioned that the assessee had furnished the following documents:

i) Copy of ISDA (International Swaps & Derivatives Association Inc.) Master Agreement entered with ICICI Bank Ltd. on dated 17/03/2007.

ii) Copy of some swap confirmations pointing out currency swap between INR-USD-CHD-JPY etc.

iii) Copy of offer letter dated 23.06.2010 given to ICICI Bank Ltd. for settlement of derivative transactions by payment of Rs. 15,43,90,000/-. The offer made was agreed to by the bank subject to withdrawal of civil suits in Court by both the parties

iv) Working of loss in foreign currency transactions amounting to Rs. 15,43,90,000/.

6.6 On the basis of the aforesaid documents the AO observed as under:

i) The agreement has been entered into for currency transactions. Etc.

ii) As per the agreement/swap confirmations the foreign currencies can be swaped like INR- USD- CHF-JPY.

iii) The assessee has not entered in derivative contracts in any Recognized Stock Exchange.

iv) The assessee has not entered into any hedge transaction for items imported or exported by it.

6.7 According to the AO the assessee had made the following claims:

i) Loss in foreign exchange transaction is on account of Mark to Market valuation.

ii) Net claim of los of Rs. 13.33 Cr. debited in the books is directly relatable to the business.

iii) The loss has crystallized and finally ascertained during the year, therefore, the same may be allowed as claimed in the return.”

6.8 The AO mentioned in para 3.8 and 3.8.1 of the assessment order dt. 21/03/2014 that the issue relating to “ mark to market” had been clarified by instruction no. 3/2010 of 23/03/2010 and that the speculative transaction is defined by section 43(5) of the Act, for the cost of repetition these are not reproduced herein. The AO after considering the submissions of the assessee observed that the loss claimed by the asessee was as a result of agreement with ICICI Bank and the assessee had incurred loss as per following details :

Murex strategy	Deal date	Deal type	Maturity Date	Outstanding (Rs.Millions)
		Initial Credit in account		-0.15
MX03943	10-Aug-07	INR to CHF POS	14-may-08	-1.47
MX03943	10-Aug-07	INR to CHF POS	14-may-08	86.95
MX03726	10-Aug-07	USD/JPY KIKO	8-Aug-08	29.50*
MX03612	12-Jul-07	INR to JPY COS	14 July 08 (interest settlement)	1.79
MX03612	12-Jul-07	INR to JPY COS	13 Jan 09 (interest settlement)	12.06
MX03612	12-Jul-07	INR to JPY COS	13 July 09 (interest settlement)	10.47
MX03612	12-Jul-07	INR to JPY COS	12 Jan 10 (interest settlement)	7.48**
MX03612	12-Jul-07	INR to JPY COS (unwind)	14-Jun-10	7. 76**
Total				154.39

–

*USD/JPY        Spot rate	Loss in JPY (115- Spot)* 1.25 mio	JPY7 INR Spot Rate	Loss in INR
109.67	76, 650,000	0.3849	29,502,585

–

**USD/JPY Fwd rate	To pay in USD (JPY 68.93 mio, /Fwd)	USD/INR Fwd Rate	Loss in INR (Fwd * USD amount -27.27 mio)
91.74	751,429	46.65	7, 780,205

6.9 The AO further observed that there was dispute in respect of the loss with the bank and a case was filed in the court of law, finally a settlement agreement was entered into with the bank on 23/06/2010 and the assessee agreed to settle the issue with the bank for a lumpsum payment of Rs. 15,43,90,000/- the said agreement was as under:

“OSWAL WOOLLEN MILLS LTD.

23.06.2010

To

ICICI Bank

Mumbai

Dear Sir,

Reg: SETTLEMENT OF DERIVATIVE TRANSACTIONS:

This refers to the without prejudice negotiations held between overseas and yourselves in regard to your bank’s claim in the above ‘ matter. At the negotiations both parties ‘acknowledged that they were envisaging establishing a long term business relationship with each other and that therefore the matter required to be expeditiously resolved.

We have agreed to pay to you (lump sum amount of Rs. 15,43,90,000/-(Rupees Fifteen Crores Forty Lacs Ninety Thousand only) which amount you have agreed to accept, in full and final settlement of all your claims in all the derivatives transactions entered between the company and your bank under ISDA Agreement executed on 17.03.2007.

On realization of the said amount of Rs. 15,43,90,000/-(Rupees Fifteen Crores Forty Lacs Ninety Thousand only) vide cheque No. 572624 dated 29.06.2010 your bank’s entire claim with respect to dues under ISDA Agreement and transactions executed there under shall stand satisfied. We also confirm ‘that in view of the settlement having been arrived at as aforesaid we shall withdraw suit No.83 of 2008. filed on/or around 03/04/2008 ( Oswal Woolen Mills Lid. Vs.- ICICI Bank Ltd.) any other proceedings initiated against the bank pending in the court of the Hon’ble Civil Judge Junior Division, Ludhiana or’any other forum.

Pursuant to which you will forthwith withdraw the Original Application No.225 of 2008 and 153 of 2009 as well as subsequent misc. applications filed by you in DRT and the Bank will not have any claim of any kind or nature whatsoever against our company or its directors, arising out of the derivative transactions entered till date under ISDA Agreement entered between your bank and our company M/s Oswal Woolen Mills Ltd.

Bot h the parties will file application for withdrawl of suit and original application in their respective case within fifteen days from the date of signing this letter or the next date of hearing of the case, whichever is earlier, subject to realization of the payment by ICICI Bank. “

6.10 The AO observed that the directions were not in relation to business carried on by the assessee and it had not been worked out on the last day of the financial year or reporting date. Hence there were no loss to the assessee which could have been set off against the income from business. He further observed that the assessee had claimed that the loss of Rs. 13.33 crores debited in the books was directly relatable to the business which was factually incorrect as the assessee was involved in the business of manufacturing yarn, textile etc. but the loss had been incurred in foreign currency transaction entered into with ICICI Bank Ltd. under a master agreement of foreign currency transaction or foreign currency swap. The transactions or the loss incurred had nothing to do with the business of the assessee and there was no mark to market valuation of loss as claimed by the assessee.

6.11 The AO also did not accept this claim of the assessee that the loss had crystallized and finally ascertained during the year, therefore, the same may be allowed as claimed in the return of income, for the reason that the loss was speculative in nature. The AO also referred to the provisions contained in section 43(5) of the Act and observed that the transaction would be speculative if it is settled “ otherwise then by actual delivery or transfer of the commodity or scrips” but in the instant case there was no actual delivery. Hence the transaction of loss is speculative in nature and that the assessee had not carried out the transaction of derivative in any recognized stock exchange. The AO also observed that the assessee had incurred the loss in purchase and sale of foreign exchange under the agreement with ICICI Bank Ltd. therefore the loss in foreign exchange was to be treated as speculative in nature. He also observed that there was a dispute between the assessee and the ICICI Bank Ltd. in the court of law, therefore the claim that the loss pertained to the year under consideration was also factually incorrect. The reliance was placed on the judgment of the ITAT Mumbai Bench in the case of M/s S. Vinodkumar Diamond Pvt. Ltd. Vs. Addl. CIT Range 5(3), Mumbai in ITA No. 506/Mum/2013 order dt. 03/05/2013.

6.12 The AO observed that the assessee had not fulfilled the conditions as laid down by the ITAT, Mumbai Bench in the aforesaid referred to order, therefore, the provisions of section 43(5)(a) of the Act were not applicable in the case of the assessee and that the assessee could not demonstrate how the transactions were not speculative transaction and were directly linked with the business. The AO treated the loss incurred by the assesee as speculative in nature by observing as under:

3.11 In view of the discussion made above, facts of the case and case law cited it is clear that the loss incurred by the assessee is speculative in nature. The fact is evident from the following:-

I. The loss is on account of exchange rate difference in currency transactions.

II. The loss has nothing to do with the business of the assessee company.. The assessee is involved in the business of yarn, textile etc. but the loss is on account of speculation in currency.

III. There is no ‘mark to market’ loss as claimed by the assessee. Even if there is ‘mark to market’ loss the same is not allowable in the case of the assessee as held by the Hon’ble ITAT Mumbai in the case M/s S. Vinodkumar Diamond Pvt. Ltd. vs Addl. C.I.T. Range5(3), Mumbai vide ITA No . 506 / Mum / 2013 dated 03. 05. 2013 , because it is not in relation to the business carried on by it.

IV. Booking and cancellation of Forward Contract of exchange were not in respect of specified export or import.

V. The forward transactions made by the assessee must have a direct connection with the goods manufactured or the merchandise sold.

VI. The assessee is not dealing in Foreign Exchange, therefore transactions entered into by it in Foreign Exchange cannot be held to be hedging transactions. It is not covered by provisions of section 43(5)(a) of the I.T. Act.

VII. The transaction of currency has not been carried out by the assessee in any recognized stock exchange. Hence it cannot be treated as business loss in view of clause (d) of section 43(5) of the I.T. Act.

Accordingly loss incurred by the assesee amounting to Rs. 13,32,96,175/- was treated as speculative in nature and the set off claimed against the income from business and profession was not allowed.

7. Being aggrieved the assessee carried the matter to the Ld. CIT(A) and reiterated the submissions made before the AO during the course of assessment proceedings. It was further stated that the provisions of section 43(5) of the Act were not applicable to the foreign currency transactions, a reference was made to the definition of speculative transaction given in Section 43(5) of the Act wherein the term commodity had not been defined. It was submitted that currency was not a commodity and therefore the provision of section 43(5) of the Act were not applicable. The reliance was placed on the following case laws:

i. Reliance Industries Ltd. Vs. CIT – 147 ITD -323 (Mumbai Bench)

ii. CIT Vs. Punch Mahal Steels Ltd. – 215 Taxman – 140(Gujrat HC)

8. The Ld. CIT(A) forwarded the copy of the submissions of the assessee to the AO who vide his report dt. 18/09/2014 justified the addition. The AO also submitted that the case laws relied by the assessee were not applicable and were distinguishable on facts. The Ld. CIT(A) provided the copy of the AO’s report to the assessee for the comments, in response the assessee furnished the written submissions dt. 17/11/2014 and stated that the assessee company during the course of business entered into derivative transaction for the purposes of hedging its business loss arising out of foreign exchange fluctuation or interest fluctuation in its day to day business activities and there was no element of speculation involved in this case. The Ld. CIT(A) after considering the submissions of the assessee observed that the following facts emerged in the assessee’s case :

(i) The appellant is carrying on the business of manufacturing of yarn, grey & processed fabrics and white crystal sugar etc.

(ii) During the F.Y. 2005-06, the appellant company had raised money from investors through FCCB (Foreign Currency Convertible Bond) for company’s business.

(iii) This FCCB instrument had provided the option to the investors to convert the amount covered by FCCB into equity shares of the company at a fixed price or alternately retain FCCB so as to claim the amount given under each bond after a specified period.

(iv) The agreement with ICICI Ltd. was for currency transactions. The head note of this agreement was “ISDA (International Swaps & Derivatives Association Inc.) Master Agreement dated 17.03.2007”.

(v) As per the agreement/ swap confirmations the foreign currencies can be swapped like INR-USD-CHF. Under the heading ‘deal type’ the conversion of currencies could be done from Indian rupees to CHF POS i.e. Swiss Frank and also from USD to CHF or vice versa.

(vi) The appellant has not entered into the foreign exchange contracts in any Recognized Stock Exchange. Hence it cannot be treated as business loss in view of clause (d) of section 43(5) of the I.T. Act.

(vii) The appellant has not entered into any hedging transaction for items imported or exported by it. Booking and cancelation of Forward Contract of foreign exchange was not in respect of specified export or import. The appellant is not dealing in Foreign Exchange, therefore transactions entered into by it in Foreign Exchange cannot be held to be hedging transactions. To be hedging transactions, the forward transactions made by the appellant must have a direct connection with the goods manufactured or the merchandise sold. It is not covered by provisions of section 43(5)(a) of the I.T. Act.

(viii) Transaction or the loss incurred had nothing to do with the business of the appellant. The appellant is involved in the business of yard, textile, sugar etc. but the loss is on account of speculation in currency. The loss is on account of exchange rate different in currency transactions.

(ix) There is no ‘marked to market’ loss.

8.1 The Ld. CIT(A) was of the view that as per the provisions of Section 43(5) of the Act speculative transaction means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. However the following transactions are not speculative transactions:

(i) A contract in respect of raw materials or merchandise entered into in the course of manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods or merchandise dealt with by the assessee.

(ii) A contract in respect of stocks and shares entered into by a dealer or investor to guard against loss in his holding of stocks and shares through price fluctuations.

(iii) A contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member.

(iv) An eligible transaction carried out in respect of trading in derivatives in a recognised stock exchange.

8.2 The Ld. CIT(A) was of the view that if the contract was settled otherwise than by actual delivery, then it would be a speculative transaction notwithstanding that the nature of the commodity was not one lending itself the possibilities of speculation or that the intention of the parties at the time when the contracts were entered into might have been to take actual delivery but this intention could not be effectuated for one reason or the other. The reference was made to the following case laws:

(i) Juvvi Subbaramaiah & Co. v. CIT (1964) 51 ITR 742 (AP),

(ii) Hoosen Kasam Dada (India) Ltd. v. CIT (1964) ITR 171 (Cal)

(iii) Abdul Gani Haji Habib v. CIT (1969) 72 ITR 6 (Cal) ,

(iv) CIT v. Ratanlal Mohanlal (1972) 86 ITR 200 (All) ,

(v) P.L. KN. Meenakshi Achi v. CIT (1974) 96 ITR 375 (Mad) and

(vi) A. Mukhukumara Pillai v. CIT (1974) 96 ITR 557 (Mad) .

(vii) CITv. Ram Chandra Gupta & Co. (1968) 69 ITR 254 (Cal)

(viii) Bhandari Rajmal Kusalraj v. CIT (1974) 96 ITR 401 (Mys)

8.3 The Ld. CIT(A) observed that the assessee had raised the following contention in support of its claim that the loss incurred on account of foreign exchange transaction was a business loss:

(a) The transactions relating to foreign exchange were hedging transactions

(b) The transactions were entered in with the view to cover the liability under FCCB amounting to more than Rs. 200 Crores.

(c) Provision of section 43(5) were not applicable in the appellant’s case as currency was not a commodity as referred to in section 43(5) of the Act.

8.4 The Ld. CIT(A) did not accept the claim of the assessee that the foreign exchange were hedging transactions for the reason that the assessee had not entered into any transaction for items imported and exported by it which is the pre-requisite for a transaction to be hedging in respect of goods manufactured and / or sold by the assessee. The reliance was placed on the following case laws:

•  M.G. Bros 154 ITR 695 (AP)
•  Delhi Flour Mills Company Ltd., 95 ITR 151 (Del)
•  M.P. Sugar Mill Pvt. Ltd., 148 ITR 203 (All)
•  CIT Vs. Ramkumar Venugopal & Co. (1993) 70 Taxman 30 (Bom)
•  Javri Subbaramaiah and Co. V. CIT (1964) 51 ITR 742 (AP)
•  Omkarmal Agarwal V. CIT (1968) 67 ITR 329 (AP)
•  Chimanlal Chhotalal V. CIT (1968) 69 ITR 129 (Guj)
•  Pankaj Oil Mills v. CIT (1978) 115 ITR 824 (Guj)(FB)
•  Kirtilal Jaisinglal & Co. v. CIT (1980) 121 ITR 779 (Bom)

8.5 As regards to the claim of the assessee that the transactions were entered into with a view to cover the liability under FCCB amounting more than Rs. 200 Crores. The Ld. CIT(A) observed that the AO had specifically pointed out that ISDA agreement revealed that the assessee had not entered into foreign exchange contracts to cover the loss of FCCB and that no evidence had been furnished by the assessee in support of its contention that the foreign exchange transactions were entered into with a view to cover the liability under FCCB. He also observed that as per the agreement the conversion of currency could not be done from Indian rupees to Swiss Frank or from U.S. Dollar to Swiss Frank etc.

8.6 As regards to the another claim of the assessee that the provisions of section 43(5) of the Act were not applicable in the assessee’s case as currency was not a commodity as referred to section 43(5) of the Act for the reason that it had not been defined in the Act and currency was not a commodity. The Ld. CIT(A) observed that there was no intention of the legislature to exclude the foreign exchange transactions not involving actual delivery out of the preview of section 43(5) of the Act, a reference was made to Notification No. 46/2009 dt. 22/05/2009 vide which MCS Stock Exchange Limited had been notified as a recognized stock exchange for the purpose of clause (ii) of Explanation to clause (d) of the proviso to sub-section (5) of section 43 and that the provision of transactions in foreign exchange not involving actual delivery were covered by the section 43(5) of the Act. The reliance as placed on the following decisions of ITAT, Mumbai Bench :

•  S.Vinodkumar Diamonds Pvt. Ltd., vs. Addl. CIT, Mumbai in ITA No. 506/Mom/2013 vide order dt. 03/05/2013
•  Araska Diamond Pvt. Ltd. vs. ACIT in ITA No. 5631/Mum/2012 vide order dt. 17/10/2014

Reference was also made to the clarification regarding losses on account of derivative transaction in foreign exchange issued by CBDT vide Instruction No. 03/2010 dt. 23/03/2010 which clarified that in a case where a loss on a foreign-derivative transaction arose on actual settlement / conclusion of the contract and was not a notional or marked to market book entry, a further question would arise as to whether such a loss was on account of speculative transaction as contemplated in section 43(5) of the Act. The Ld. CIT(A) also observed that the Proviso (d) below sub-section(5) of section 43 of the Act inserted by the Finance Act, 2005, with effect from 1/04/2006 lays down that any eligible transaction in respect of trading in derivatives referred to in clause (a(c) of section 2 of the Securities Contracts (Regulation) Act, 1956, which had been carried out in a recognized stock exchange shall not be treated as a speculative transaction and any loss in a speculative transaction can be set off only against profit from speculative transaction.

8.7 The Ld. CIT(A) held that the AO was fully justified in holding that the loss incurred by the assessee on account of foreign exchange transaction not involving actual delivery was speculation loss.

9. Now the assessee is in appeal.

10. The Ld. Counsel for the assesse reiterated the submissions made before the authorities below and further submitted that the assessee was engaged strictly as per its Memorandum of Association and Articles of Association, in the business of manufacturing and export of woolen / blended Yarn and during the F.Y. 2006-07 to 2010-11 the assessee exported yarn as per following details;

Asstt. Year	Amount (Rs.)
2007-08	23,82,99,743/-
2008-09	16,90,51,886/-
2009-10	13,78,62,476/-
2010-11	14,25,07,223/-
2011-12	11,08,14,904/-

It was further stated that the assessee also imported goods i.e; Raw materials, capital goods and stores during those years as per following details:

Asstt. Year	Amount (Rs.)
2007-08	99,56,40,721/-
2008-09	97,37,99,631/-
2009-10	84,48,31,610/-
2010-11	1,00,63,87,312/-
2011-12	1,58,36,81,214/-

10.1 It was stated that the assessee was not carrying on any trading activity of foreign exchange either in India or outside India for the assessment year under consideration namely A.Y. 2011-12, either before thereto since its incorporation and / or thereafter till date it had actually not carried out any trading activity of foreign exchange either in India or outside India dehors the object clause contained in the Momorandum and Article of Association. It was further stated that the assessee during the year under consideration claimed Rs. 13,32,96,175/-(Rs. 79,09,196 debited in P&L A/c Rs. 12,53,86,979/- shown as disputed liability in Balance Sheet) as foreign exchange hedging loss in the computation of taxable income, the said amount was claimed as revenue expenditure. It was further stated that the AO during the proceeding under section 143(3) of the Act required the assessee to furnish the working of the said loss alongowith justification for deduction of the said amount as revenue expenditure from the business profits; and further directed the assessee to explain as to why the transaction was not speculative transaction under section 43(5) of the Act. In reply thereto the assessee vide its reply dt. 28/02/2014 (copy of which is placed at page no. 27 to 32 of the assessee’s paper book) submitted therein that to cover up the expected loss on fluctuation of foreign exchange on the liability incurred during the course of regular business, the ICICI Bank having fiduciary relationship with the assessee had suggested to hedge the liability as permitted under FEMA & RBI through derivatives contracts. Accordingly, the assessee company had to cover up its financial liability under import which was to be paid in foreign currency to the suppliers, entered into derivative contracts with the banks and as per banking guidelines, the said bank asked the assessee to file board approval which authorized the assessee company to enter into hedging transaction and that the board approval for the same was obtained as a result thereof vide resolution dt. 27/12/2006, copy of which is placed at page no. 33 of assessee’s paper book which was also furnished to the authorities below. It was further stated that the assessee company filed detailed submissions dt. 17/11/2014 (copy of which is placed at page no. 34 to 37 of the assessee’s paper book), before the Ld. CIT(A) Ludhiana on the issue that Foreign Currency Transactions were made to hedge the financial liability related to normal business of goods imported for the manufacturing and sales & export of goods. However, unfortunately ever since in the beginning of year 2007 the foreign exchange market started fluctuating in a very unusual and unexpected manner. Thus the liability for this hedging contracts entered by the assessee with the bank in the normal course of business started generating heavy liability on account of unexpected fluctuation in foreign exchange in global market and the hedging contracts were abandoned by the assessee and whatever the liability arose for the purposes of hedging the business transactions, the assessee chose to pay off and accordingly the net liability for such hedging had been provided in the books of account as foreign exchange hedging loss as well as claimed in the return and since this liability had arisen during the course of business in the year under consideration; therefore, the amount was claimed as a revenue expenditure.

10.2 The Ld. Counsel for the assessee submitted that the Ld. CIT(A) as well as the AO misdirected themselves in law as well as on facts in holding that the transactions relating to foreign exchange could not be held to be hedging transaction, and furnished the submissions in writing which is reproduced verbatim as under:

a) The findings recorded by the CIT(A) that the transactions relating to foreign exchange were not hedging transactions in the absence of the essential prerequisite that the transaction is in respect of goods manufactured and/or sold by the appellant, is not correct in view of the admitted factual position emerging from the material on record namely, that the transaction for hedging business loss if caused as a result of fluctuation in the foreign currency as a matter of business preposition had a direct nexus between the derivative product and the business activity namely import of goods for manufacturing activity by the assessee company and selling of goods and augmentation of the same for its utilization for said business activity of manufacture and sale of goods. Admittedly, the assessee is engaged in the manufacturing of yarn, cloth & garments etc. Its business does not extend to dealing in foreign exchange as admitted by both the authorities i.e., CIT(A) as well as the Assessing Officer. The transaction of derivative product as evidenced by the Board’s resolution and the ISDA master agreement entered into between the Bank and the assessee was hedged to meet the financial loss on account of fluctuation of foreign currency to cover the financial liability of the company because of unexpected fluctuations in foreign exchange currency in global market compelled as a matter of commercial expediency, to be viewed from the point of view of the assessee, to settle the derivate loss during the year relevant to the assessment year and therefore, the amount of said loss was rightly claimed as business expenditure/loss by the assessee. The intention of the assessee, thus, was to hedge the transaction for securing business loss. Such type of hedging transactions, it is well settled, are recognized as per law in India and one such decision in regard thereto is the decision rendered by the Hon’ble High Court of Madras in the case of Rajshree Sugars & Chemicals Limited Vs. Axis Bank Limited & Anr., 2008 SCO On Line Mad 746 : AIR 2011 Madras 144. Hedging transactions of financial liability are not opposed to public policy nor void agreements under Section 23 of the Indian Contract Act, 1872 moreso when such a transaction is not expressly included by the legislature treating the assessee entering into such a transaction as being engaged in the business of speculation and/or such a transaction as a speculative transaction under Section 28 read with Section 43(5) of the Act, and therefore, on the anvil of the settled principle of law that one arm of law cannot be utilized to defeat the other arm of law and doing so would be opposed to public policy and bring the law into ridicule{Bihari Lai Jaiswal v. CIT [1996] 217 ITR 746 (SC)/ 84 Taxman 236 (SC) followed by the jurisdictional High Court of Punjab & Haryana, Chandigarh in Commissioner of Income-tax v. Jagdish Chand Walia [1998] 234 ITR 595 (Punjab & Haryana)/[1998] 144 CTR 127 (Punjab & Haryana)}, the finding recorded by the learned CIT(A) that hedging transaction of financial liability against import & export of goods is speculative as such a transaction is not in respect of goods manufactured and/or sold and the assessee is not dealing in foreign currency, is not tenable in law both on principle and precedent. The judgments relied upon by the CIT(A) while holding that the transactions in foreign exchange on account of financial liability were not hedging transaction and fell within the purview of Section 43(5) of the Act are not at all applicable to the case of the assessee leave alone an answer to the preposition that hedging transaction of financial liability is not a speculative transaction and/or an assessee engaged in the business of manufacturing entering into a transaction of hedging its liability cannot be said to be a speculative business and/or a speculative transaction so as to invite the applicability of the provisions of Section 28 read with Section 43(5) of the Act.

The assessee in view of its Board s resolution and copy of ISDA master agreement establishing that the transaction relating to foreign exchange were hedging transactions discharged its burden and in the circumstances namely, when the assessee was not engaged in the trading of foreign currency, no evidence has been brought on record by the Assessing Officer contradicting the stand of the assessee, therefore, the transaction relating to foreign exchange were hedging transactions and consequently the amount of business loss caused thereof was rightly claimed as a business loss and by no stretch of imagination the transaction could be held to be a speculative transaction thereby calling for the invocation of the provisions of Section 43(5) of the Act at the instance of the Assessing Officer for making a disallowance thereunder. The assessee for the aforesaid submissions relies upon the Judgments/Orders rendered by the Hon ble High Courts and various coordinate Benches of the Hon ble Income Tax Appellate Tribunals which are as follows: (i) Commissioner of Income-tax v. Soorajmul! Nagarmull [1981] 129 ITR 169 (Calcutta)/[ 1981] 22 CTR 6 (Calcutta); (ii) Commissioner of Income-tax v. Badridas Gauridu (P.) Ltd[2003] 261 ITR 256 (Bombay)/[2004] 187 CTR 453 (Bombay); (iii) Commissioner of lncome-tax-16, Mumbai v. D. Chetan & Co [2017] 390 ITR 36 (Bombay)/[2017] 295 CTR 365 (Bombay); (iv) Commissioner of lncome-tax-16, Mumbai v. Vishindas Holaram [2014] 50 taxmann.com 337 (Bombay)/[2015] 229 Taxman 30 (Bombay); (v) Commissioner of Income-tax v. Friends and Friends Shipping (P.) Ltd. [2013] 35 taxmann.com 553 (Gujarat)/[2013] 217 Taxman 267 (Gujarat); (vi) Commissioner of Income-tax – III v. Panchmahal Steel Ltd. [2013] 33 taxmann.com 10 (Gujarat)/[2013] 215 Taxman 140 (Gujarat); (vii) SCM Garments (P.) Ltd. v. Deputy Commissioner of Income-tax, Central Circle-III, Coimbatore [2015] 59 taxmann.com 395 (Chennai – Trib); (viii) Majestic Exports v. Joint Commissioner of Income-tax, Tripur Range, Triupu [2015] 62 taxmann.com 307 (Chennai –Trib)/[2015] 172 TTJ 504 (Chennai – Trib.)i (ix) Reliance Industries Limited v. Commissioner of Income-tax, Large Taxpayer unit [2013] 40 taxmann.com 431 (Mumbai – Trib.)/[2014] 147 ITD 323 (Mumbai – Trib.). It is submitted that the finding recorded by the CIT(A) holding that the transactions in foreign exchange entered into by the assessee could not be held to be a hedging transaction is therefore, not sustainable and deserves to be vacated.

(b) The learned CIT(A) as well as the Assessing Officer committed a serious error of law in holding that the transaction of foreign exchange in the case of the assessee not involving actual delivery was covered by the provisions of Section 43(5) of the Act. It is submitted that when admittedly the assessee is not a dealer in foreign exchange, and the transaction was entered with the Bank to cover the financial liability against import & export business, the provisions of Section 43(5) of the Act did not apply to the case of the assessee as the prerequisite condition for invocation of the said provision namely, that there should be a transaction of purchase and sale of any commodity including stocks and shares, which is periodically and untimely settled otherwise than by actual delivery or transfer of commodity; and on a true and correct interpretation of the word ‘commodity’ especially in the absence of the said word not having been defined under the Act and in view of the succeeding words ‘stocks and shares’ would not include a transaction of ‘foreign currency’ Foreign exchange i.e currency is the price to be paid in the terms of any contract for the purchase or sale of any commodity but would not be a commodity .More over during the Asstt proceedings no enquiry was made from the bank by Assessing officer u/s 133(6) or 133 of the act to constraint the stand of the assessee while arriving at a conclusion that the matter in question was not a hedging transactions. Thus, the addition made by applying the provisions of Section 43(5) of the Act is not sustainable inasmuch as the transaction in question did not fall with the definition of speculative transaction as per Section 43(5) of the Act.

Reliance was also placed on the following decisions of various Benches of the Tribunal :

• The ACIT, Bangalore Vs. M/s Lifestyle International (P) Ltd. in ITA No. 2258/Bang/2016 vide order dt. 19/04/2021 (Bangalore Trib)
• The DCIT v. Kunnam Granite Works, (2022)136 taxmann.com 415 (Chennai Trib)
• SCM Garments (P) Ltd. v. DCIT [2015] 59 taxmann.com 395 (Chennai Trib)
• The DCIT, Rajkot v. DML Exim (P.) Ltd. [2020] 118 taxmann.com 491 (Rajkot Trib)

11. In his rival submissions the Ld. CIT DR reiterated the observations made by the authorities below and strongly supported the impugned order passed by the Ld. CIT(A). It was further submitted that the assessee had not entered in derivative contract in any recognized stock exchange and had also not entered into any hedging transaction for items imported or exported by it. It was stated that the foreign currency transaction or loss incurred had nothing to do with the business of the assessee rather it was a speculative in nature and that the assessee could not demonstrate how those transactions were directly linked with the business of the assessee. It was further stated that the transactions had been done without taking actual delivery therefore the provisions of section 43(5) of the Act were applicable as the transactions were speculative in nature.

12. The Ld. CIT DR accordingly submitted that the Ld. CIT(A) was fully justified in sustaining the addition made by the AO.

13. We have considered the submission of both the parties and perused the material available on the record. In the present case the assessee was in the business of manufacturing of yarn processed fabrics and sugar etc., it was not carrying on any trading activity of foreign exchange either in India or outside India since its incorporation. During the year under consideration the assessee debited Rs. 13,32,96,175/- as foreign exchange hedging loss under the head financial expenses. However the AO did not accept the claim of the assessee and made the disallowance by invoking the provisions of section 43(5) of the Act. The Ld. CIT(A) also sustained the view of the AO and held that the transactions relating to foreign exchange were not hedging transaction. In the present case the assessee on the suggestion of the ICICI Bank and to cover up the expected loss on fluctuation of foreign exchange and the liability incurred during the course of regular business hedged the liability as permitted under FEMA and RBI Act through derivative contract. The assessee obtained the approval of the Board of Directors vide resolution dt. 12/09/2006 copy of which was placed before the AO during the course of assessment proceedings and the same is placed at page no. 33 of the assessee’s paper book. As per the claim of the assessee, the foreign exchange market started fluctuation in a very unusual and unexpected manner, thus the liability for hedging, the contract entered by the assessee with the ICICI Bank in the normal course of business started generating heavy liability on account of unexpected fluctuation in foreign exchange in global market and the hedging contracts were abandoned by the assessee, whatever the liability arose for the purpose of hedging, the assessee chose to pay off and the net liability for such hedging had been provided in the bank account as foreign exchange hedging loss under the head financial expenses. In the present case the assessee raise funds through FCCB (Foreign Currency Convertible Bonds) for the purpose of manufacturing and selling of goods. The transaction of derivative products as evidenced by the Board Resolution dt. 12/09/2006, copy of which is placed at page no. 33 of the assessee’s paper book and the ISDA master agreement entered into between the bank and assessee company was hedged to meet the financial loss on account of fluctuation of foreign currency to cover the financial liability of the assessee company. The assessee as a matter of commercial expediency because of unexpected flucutations in foreign exchange currency was compelled to settle the derivative loss during the year under consideration and claimed the said loss as business expenditure. The intention of the assessee was to hedge the transaction for securing business loss. Such type of transaction are recognized as per law in India.

13.1 On a similar issue the Hon’ble Madras High Court in the case of Rajshree Sugars & Chemicals Limited Vs. Axis Bank Limited & Anr. Reported at AIR 2011 Madras 144 held that hedging transaction of FCCB’s liability are not opposed to the public policy nor void agreements under section 23 of the India Contract Act, 1872.

13.2 In the present case the assessee was engaged in manufacturing of yarn, processed fabrics, sugar and export of cotton yarn, its business did not extend to dealing in foreign exchange. However, to cover up the expected loss on fluctuation of foreign exchange on the liability incurred during the course of regular business, the ICICI Bank having fiduciary relationship with the assessee had suggested to hedge the liability has permitted under FEMA and RBI through derivative contract. The assessee company had to cover up its financial liability under import which was to be paid in foreign currency to the supplier, entered into derivative contract with the bank and as per the banking guidelines, the ICICI Bank asked the assessee to file the approval of Board of Directors which authorizes the assessee company to enter into hedging transaction. In response the Board approval was obtained vide Resolution dt. 27/12/2006 copy of which is placed at page no. 33 of the assessee’s paper book. It is also noticed that the assessee furnished the submission dt. 17/11/2014 before the Ld. CIT(A) copy of which is placed at page no. 34 to 37 of the assessee’s compilation, on the issue that foreign currency transactions were made to hedge the financial liability related to normal business of goods imported for the manufacturing of sale and export of goods. In the instant case the liability for the hedging contract entered by the assessee with the bank claimed to be in normal course of business started generating heavy liability on account of unexplained fluctuation in the foreign exchange in global market, therefore, the hedging contract were abandoned by the assessee and whatever the liability arose was paid off accordingly the net liability for such hedging had been provided in the books of account as foreign exchange hedging loss and claimed as a revenue expenditure. In our opinion the derivative transaction entered into with the bank for the purpose of securing expected business loss arising out of foreign exchange fluctuation cannot not termed as speculative since the same is particularly carried out to safeguard expected business loss.

13.3 In the present case the assesse during the course of its regular business entered into derivative contract for the purpose of hedging its business loss arising out of exchange fluctuation in its day to day business activity and there was no element of speculation involved.

13.4 In the assessee’s case no derivative contract could be entered into without underlying assets. A derivative means a financial instrument whose value changes in response to change in a specific interest rate, security price, commodity price, foreign exchange rate, index of price or rates, a credit rating or credit index which requires no initial net investment or little net investment relative to other types of contract that have a similar response to changes in market condition and it is settled at a future date, in such type of cases, risk embedded in underlying assets is to be protected by means of derivative contracts invented by the banking institutions but it is neither with the intention nor it can be foreign exchange delivery. It is for the purpose of protection of difference in exchange rate by determination of value of a given currency in a given period. In India, in the case of foreign currency derivative, interest rate derivative and credit derivative, RBI is empowered to regulate for the regulatory purposes. The RBI Act has defined the derivative as under;

“Derivative means an instrument, to be settled at a future date, whose value is derived from change in interest rate, foreign exchange rate, credit rating or credit index, price of securities (also called “underlying”) or a combination of more than one of them and includes interest rate swaps, forward rates agreements, foreign currency swaps, foreign currency rupee swaps, foreign currency options, foreign currency – rupee options or such other instruments as may be specified by the bank from time to time.”

As per the RBI guidelines the user can undertake derivative transaction to hedge – specially reduce or extinguish an existing identified risk on an ongoing basis during the life of derivative transactions or for transformation of risk exposure as specially permitted by RBI.

13.5 On a similar issue the ITAT Bangalore Bench ‘A’ in the case of ACIT Vs. M/s Lifestyle International(P) Ltd. in ITA No. 2258 and 2259/Bang/2016 for the A.Y’s 2008-09 and 2010-11 vide order dt. 19/04/2021 (supra)held in para 5.5 to 5.11 as under:

5.5 We have heard rival submissions and perused the material on record. The forward contracts were entered into mainly to hedge the import payments and working capital loans repayment which is in the ordinary course of trade or business of the assessee. The hedging contracts are in the nature of foreign exchange contract to purchase foreign exchange on a specified future date at a predetermined date. The bankers levied premium for entering into such forward contract. These are in the nature of actual charges levied by the bankers. It is nothing but bank charges which is purely revenue in nature. The said expenditure is incurred to secure the assessee’s business from foreign exchange fluctuation risk. In case the assessee would not have taken the forward contract to cover itself from fluctuation risk, it can lead to making higher payment of imports and incurring huge losses, which could result in lesser profit. The Hon’ble Calcutta High Court in the case of CIT v. Britannia Industries Ltd. reported in [2015] 376 ITR 299 (Calcutta) had held that “consideration paid by the assessee to the authorized dealer of foreign exchange, which is the bank in this case, in order to obtain protection from fluctuation of foreign exchange rates is a revenue expenditure”.

5.6 As per section 43(5) of the I.T.Act, speculative transaction means a transaction in which the contract for purchase or sale of any commodity including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. The definition also provides for certain exceptions. A speculative transaction is characterized by four features, namely –

(i) it is a contract for purchase or sale;

(ii) The purchase or sale should be of a share, stock or commodity;

(iii) There should be periodical or ultimate settlement of the contract;

(iv) Settlement to be otherwise than by actual delivery or transfer.

5.7 In order to attract the definition of a speculative transaction, all the characteristics mentioned in the said definition is required to be satisfied. Definition of a speculative transaction vis-a-vis forward cover are as follows:-

(i) A forex cover is a contract for purchase or sale and thus the first characteristic as per section 43(5) is satisfied. The third and fourth characteristic of periodic and ultimate settlement and settlement other than by actual delivery would be satisfied in a forex cover transaction.

(ii) The second characteristic is that the purchase should be of a share, or stock or commodity. A forex cover is not a contract for the purchase of a share or a stock. In a forex cover, the purchase or sale is towards foreign currency. Therefore it has to be seen whether foreign currency can be equated with the term “commodity” such that its purchase or sale triggers the definition of a speculative transaction under the Act.

5.8 The term “commodity” has not been defined under the Income Tax Act Black’s Law Dictionary (8th Edition) defines the term “commodity” as an article of trade or commerce; the term embraces only tangible goods, such as products or merchandise, as distinguished from services; an economic good, especially a raw material or an agricultural product.

5.9 The other definitions include:

(i) Articles of commerce

(ii) Anything movable which is bought and sold

(iii) A raw material that can be sold

(iv) An article of trade or commerce, especially an agricultural or mining product that can be processed and resold

(v) Reasonably homogenous good or material bought and sold freely as an article of commerce. Commodities include agricultural products, fuels, metals, etc., and are traded in bulk on a commodity exchange or on spot market.

5.10 The Delhi Bench of ITAT in the case of Munjal Showa Ltd. v. DCIT, has held as under:

“Foreign currency or any currency is neither commodity nor shares. The Sale of Goods Act specifically excludes cash from the definition of goods. Besides, no person other than authorised dealers and money changers are allowed in India to trade in foreign currency, much less speculate. S. 8 of the Foreign Exchange Regulations Act, 1973, provides that except with prior general or special permission of the RBI, no person other than an authorised dealer shall purchase, acquire, borrow or sell foreign currency. In fact, prior to the LERMS, residents in India were not even permitted to cancel forward contracts. The presumption of any speculative transaction is, therefore, directly rebutted in view of the legal impossibility and in view of the fact that foreign currency was neither commodity nor shares. “

5.11 Based on the above, foreign currency does not fall within the purview of the term “commodity” and hence this characteristic of a speculative transaction is not satisfied. Since, the definition of speculative transaction itself is not applicable to the assessee’s case as all the conditions were not satisfied, treating the transaction as speculative in nature is not sustainable in law. Therefore, we hold that the CIT(A) is correct in deleting the disallowance of premium on forward contract and no interference is called for. It is ordered accordingly.

In the present case also the assessee entered into forward contract with the ICICI Bank to hedge the import payments and repayments of the loans therefore the transaction entered into by the assessee was not speculative transaction.

13.6 Similarly the ITAT Chennai Bench ‘A’ in the case of DCIT Vs. Kunnam Granite Works (supra) held in para 8 & 9 as under:

8. We have heard both the parties, perused the materials available on record and gone through orders of “me authorities below. The facts borne out from record clearly indicated that assessee had entered into business of export of monument granite blocks to Japan Companies through their Chinese Intermediaries. The Chinese Intermediaries would be making the payment in USD with a future possibility of the direct payment by Japan customers in Japanese Yen depending on the currency fluctuation. As agreed by the parties, the assessee had achieved export sales of Rs. 50.53 Crs. for the FY relevant to the AY 2009-10. Since, the assessee had huge export receivables from customers, it had entered into a Forex derivative transaction with State Bank of India to hedge the foreign currency risk involved in these transactions. The assessee has treated profit or loss arised on account of fluctuation of foreign currency as income or expenses, as the case may be, in the relevant AYs. The Department has accepted the income declared by the assessee on account of Forex gain whenever the assessee has earned gain from appreciation in foreign currency. However, disputed loss claimed for the year under consideration only on the ground that derivative transactions entered into by the assessee is in the nature of speculative transaction, which does not come under proviso (d) to sec.43(5) of the Act.

9. We have gone through the reasons given by the AO to treat Forex loss incurred by the assessee on account of derivative transactions as speculative transactions in light of various arguments advanced by the Ld.AR for the assessee and we ourselves do not subscribe to the reasons given by the AO for the simple reason that the assessee being an export of goods to Japan Company had entered into hedging transactions with State Bank of India by entering into Forex derivatives to minimize possible loss in fluctuation in USD, because the Japanese Companies agreed to make the payments through their Chinese Intermediaries by USD. Further, during the year under consideration, the assessee achieved an export turnover of Rs.50.53 Crs. which is much more than the amount of derivative contracts entered into by the assessee with State Bank of India. We further noted that when the assessee enters into a hedging transaction to minimize the possible loss from fluctuation in foreign currency, then profit or loss arises on account of appreciation or depreciation in the value of foreign currency held by it on conversion into another currency, such profit or loss would ordinarily be a trading profit or loss, if the foreign currency is held by the assessee on Revenue account or as a trading asset or as a part of circulating capital embarked in the business, if the underline asset is more than the amount of forward contracts entered into by the assessee. This legal principle is supported by the decision of the Hon ble Supreme Court in the case of Woodward Governor India (P.) Ltd. (supra), and it is also supported by the principles laid down by the Hon ble Bombay High Court in the case of CIT v. VS. Dempo & Co. Pvt. Ltd. [1994] 72 Taxman 134/206 ITR 291 (Bombay), wherein, it was held that the loss arising in the process of conversion of foreign currency, which is part of trading asset of the assessee, is a trading loss as any other loss. In this case, the facts available on record clearly shows that the assessee being an export of goods had huge receivables from customers entered into a hedging contract with its bankers to minimize the possible fluctuation in foreign currency, which resulted in loss and the same has been treated as Revenue expenditure or business loss. The Ld. CIT(A) after considering the relevant facts has rightly held that loss incurred by the assessee on account of fluctuation in foreign currency, is in the nature of business loss, but not speculative loss, which is covered u/s.43(5) of the Act. Facts remain unchanged. The Revenue failed to bring on record further evidences to prove the findings of facts recorded by the Ld. CIT(A) are incorrect. Hence, we are inclined to uphold the findings of the Ld. CIT(A) and dismissed the appeal filed by the Revenue.

In the present case also the assessee entered into forex derivative transaction with the ICICI Bank to hedge the foreign currency risk involved in the transaction therefore the expenses claimed by the assessee were revenue in nature, for the reasons that the derivative transaction entered into by the assesse was not in the nature of speculative transaction.

13.7 A similar view has been taken by the ITAT, Rajkot Bench in the case of DCIT, Circle-1(2, Rajkot Vs. DML Exim(P) Ltd.(supra) wherein relevant findings have been given in para 14 which read as under:

14. We have heard the respective parties, we have also perused the relevant materials available on record Including the orders passed by the authorities below. It appears that the assessee made the following submission before the Ld. AO:—

“Normally when we confirm any export sale contract, to prevent any future loss due to change in exchange rates we book (hedge) dollars from our Banker Oriental Bank of Commerce where we have document discounting limits. Latter on we submit the documents for collection/discount against this dollar booking contracts.

Firstly we only sales the dollars and never purchase dollars. After dollar booking we give sales documents for collection/discount. Before the expiry of the contract if we cannot submit the documents then the unutilized part of contract is settled by the bank.

Thus the forward contracts done by us are only one sided and only for the purpose of hedging and not the purpose of doing any speculative gain or loss.

Thus if we book dollar for latter period then we get more rate i e. we get premium as per RBI & Banking premium rules.

Similarly if we give the documents against future period of booking then the bank get back the premium of the same and this charges they debit to our account under the head of Forward Contract early delivery charges. Thus the forward contract early delivery charges paid by us are just return back of excess premium which we get at the time of booking of dollar. This amount is not at all speculative but it is routine practice and part and partial of the banking and export business transactions.”

Though in spite of the same the AO termed the dollar bookings, which was not set off against the dollar remittance, as speculation and not hedging since there is booking in excess of the actual remittance accepted to be received. However, as we find from the records while allowing the claim of the assessee the Ld. CIT(A) observed as follows:—

“7.2 I have perused the assessment order and the written submission filed by the Id. AR.

The AO vide para 7 of the assessment order had held that the fluctuation in foreign currency arose on account of the dollar bookings by way of advance contracts entered into by assessee with the banks against which the realization of dollar at the time of export is adjusted and the extent of the unutilized dollar booked in advance by the assessee with the bank which remained outstanding at the end of the month, was closed by the bank by crediting/debiting the assessee’s account to the extent of the unused dollar left behind out of the dollar booking for want of export realization, is speculative I nature. According to the AO, this settlement is done on a month to month basis by the ban and there is no squaring up of transactions by way of actual realization of dollar. On the other hand, the Id. AR submitted that, in the appellant’s export business, there is always a risk of fluctuating foreign currency at the time of realization of sale proceeds. Therefore in order to hedge against the loss, the appellant enters into forward contracts with its bank and tries to minimize the risk on account of fluctuation in foreign exchange against the future export sales realization. It is also seen that, forward contracts are extensively used to get export receivables hedged against adverse currency movements. The Id. AR also admits that, such contracts are only executed against the export receivables and these facts are clearly mentioned in the said contract. So it can be said that the transactions involved in these contracts have direct nexus with the export of specific merchandise and export receivables. The appellant’s Id. AR also brought on record the large fluctuation in foreign currency during the relevant financial year, in order to justify the appellant’s action of currency hedging. This is summarized supra, in the written submission. As per this chart, there is variation of upto 10 USD between May 2011 and December, 2011.

I find substantial force in the above contention of the Id. AR . It is also seen that the issue is now squarely covered by the decision of the Hon. Gujarat High Court in the case of CIT v. Panchmahal Steel Ltd. where it relied upon its own decision in the case of Friends and Friends Shipping (R) Ltd., wherein it was held that though the assessee is not a dealer in foreign exchange, it entered into forward contracts with banks for the purpose of hedging the loss due to fluctuation in foreign exchange while implementing the export contracts. The transactions in foreign exchanges were incidental to the assessee’s regular course of business and the loss was thus not a speculative loss under section 43(5) but was incidental to the assessee’s business and allowable as such. Thus, the hedging of currency is incidental to the appellant’s business and the same is therefore held as allowable business expenditure. The disallowance made by the AO is therefore directed to be deleted.”

Thus, from the above it appears that it is specific observation made by the Ld. CIT(A) that though the assessee is not a dealer in foreign exchange it had entered into forward contracts with banks for the purpose of hedging the loss due to fluctuation of foreign exchange while implementing the export contracts. Such transaction in foreign exchanges were truly identical to the assessee’s regular course of business and hence the loss is not a speculative one under section 43(5) of the Act; the same is incidental to the assessee’s business and hence allowable. We, therefore, taking into consideration the entire aspect of the matter find no infirmity in the order passed by the Ld. CIT(A) in deleting the addition made by the Ld. AO on the premise that hedging of currency is incidental to appellant’s business and thus the same is allowable business expenditure, in the present facts and circumstances of the case so as to warrant interference. We, thus, find no merit in the case made out by the Revenue. Hence, the order is passed in the affirmative i.e. in favour of the assessee and against the Revenue.

In the present case also the assessee was not a dealer in foreign exchange, it had entered into forward contract with ICICI Bank for the purpose of hedging the loss due to fluctuation of foreign exchange while implementing export contract therefore the foreign exchange loss incurred by the assessee was not speculative one under section 43(5) of the Act. The same was incidental to the assessee’s business and hence allowable.

13.8 Similar view has been taken by the ITAT Chennai Bench ‘C’ in the case of SCM Garments(P.) Ltd. Vs. DCIT (supra) wherein relevant findings has been given in para 7 to 11 which read as under:

7. We have heard the rival submissions and carefully perused the material on record and case laws relied by both the parties. In this case before us, one of the major business activities of the assessee is export of business garments as it appears from the financial statements submitted by the assessee. Therefore, it is obvious that the assessee would be having huge sundry debtors resulting from export of garments which are receivable in the foreign currency. These sundry debtors are exposed to currency fluctuation risk. One of the methods to protect loss against foreign currency fluctuation is by way of ‘hedging’. Hedging transactions are entered in order to protect against the loss due to compensatory price movement. It protects an asset or liability against fluctuation in foreign exchange rate. One of the tools for hedging the forex risk is by way of foreign currency derivatives. Section 45 of the Reserve Bank India Act, 1949 defines derivative as a financial instrument whose value depends on the value of the underlying exposures. In the case before us, the underlying exposure is the foreign currency. The commonly used forex derivatives are Forward contracts, Options contracts and Swap contracts. These instruments are used to hedge the currency risk on account of adverse currency movements. In the present case before us, the assessee has selected to book “Options Contract” as per the advice of its bankers in order to hedge its foreign exchange risk. “Options contract” is a right to exercise the option of buying or selling of a foreign currency at a particular price. However, the assessee is not compelled to buy or sell, if the spot market prices are favorable or not favorable. The cost of this “option” is called ‘Option Premium’. Upon the payment of the same, the exporter is hedged against adverse currency movement and also not liable to loose in case of favorable currency movement. Therefore, it is apparent in the case of the assessee that the assessee had entered into “Options Contract” (derivative) with the bank in order to hedge its foreign exchange risk. In the case of the assessee, what has happened is that due to adverse foreign exchange movement, the bank has debited the loss to the assessee’s account. Thus, the loss debited by the bank in the assessee’s account has crystallized and is a realistic loss suffered by the assessee. In these circumstances, the issue under consideration before us is that, whether loss on account forex derivates are to be considered as a business loss in parlance with Section 28 of the Act. Further, in the case of the assessee before us, the following facts emerge and the legal issues involved are discussed and summarized herein below:-

(i) The assessee has entered into forex derivative transactions only in order to contain the foreign currency fluctuation risk.

(ii) Thus, the loss on account of forex derivative transactions are directly attributable to the normal business of the assessee.

(iii) The loss incurred by the assessee is realistic and not notional.

(iv) Only money changers and banks are allowed to trade in foreign currency and the assessee is neither a money changer nor a bank.

(v) The assessee has only utilized the service of nationalized bank in order to iron out the loss arising out of foreign currency fluctuation risk by entering into forex derivative contract.

(vi) The Special Bench of the ITAT, Kolkata Bench in the case of Shri Capital services Ltd Vs. ACIT in 121 ITD 498(Kol.)(SB) has held that foreign currency is neither commodity nor shares as defined U/s. 43(5) of the Act.

(vii) The Instructions issued by CBDT Instruction No.03/2010 dated 23.03.2010 has recognized the loss out of forex derivatives on actual settlement/conclusion of contracts as allowable business loss, however they have directed the Revenue to examine whether the transactions would fall U/s. 43(5)(d) of the Act, and if so to treat the same as non-speculative transaction. By the above directions, it appears that though the CBDT has recognized the loss arising out of forex derivatives on actual settlement of the contracts, directed the Revenue to treat the same as speculative transaction when they are transacted through nationalized banks and as not speculative, when these transactions are transacted through recognized stock exchange.

(viii) It is pertinent to note here that the bankers act as an advisory agent to the assessee in order to protect them from foreign exchange exposure by using their expertise and these services cannot be obtained by the assessee in the stock exchange where their scope of service is very limited.

(ix) In the present case the assessee has taken a hedging position to the extent of `1.05 crores and USD `3 crores during the period 2007-2009 based on the RBI guidelines. The guidelines permitted hedging to the extent of last three years annual average turnover, or current year’s actual export turnover whichever is higher. Where exact amount of underline transaction was not ascertainable according to RBI guidelines, the contracts could be booked on the basis of reasonable estimate. The assessee has taken its hedging position in accordance with the guidelines of RBI and the same is not disputed.

(x) The claim of the assessee was that the underlying exposure both in respect of Euro and USD is more than adequate to cover the hedging positions taken in respect of cross currency derivative contracts entered into by the assessee. The Revenue has not brought out any material on record to controvert to this claim of the assessee.

(xi) Since the assessee has entered into foreign currency derivative contract adequate enough to cover the overall exposures of foreign currency, the contention of the Revenue that the proportion of the loss in derivatives is eight times more than the loss from currency fluctuation does not have any merits.

(xii) The forex derivative transactions transacted by the assessee are through nationalized banks in compliance with the RBI regulations. These regulations permit the assessee to enter into such derivative transactions only by fulfilling certain conditions in the course of the business of the assessee These regulations do not permit the assessee to enter into forex derivative contract as a separate business.

(xiii) Section 73(1) of the Act restricts the set off of speculation loss against the other business income in only those cases were speculative transactions carried on by the assessee are of such nature so as to constitute a business by itself. It is pertinent to mention here that RBI does not permit any bank under its umbrella to entertain its client in any separate business of forex derivative transactions. Permission is granted only for the clients of the bank to hedge on foreign exchange in order to minimize the risk of the foreign currency exposure arising out of import and export trade.

(xiv) The Hon’ble jurisdictional Madras High Court in the case M/s.Rajashree sugars and chemicals Ltd Vs. Axis Bank Ltd., in O.A Nos.251 & 252 of 2008 in C.S.No.240 of 2008 O.A. Nos.526 & 527 of 2008 in C.S No.240 of 2008A. Nos.1926, 1927, 2446 and 2447 of 2008 in S.S No.240 of 2008 vide order dated 14.10.2008 reported in 8 MLJ 261 has held that derivative transactions ceased to be speculative transactions or wages because pricing of the deal follows a scientific pattern on the basis of financial mathematics. Just as actuaries scientifically determined the value of insurance risk and the premium payable, Financial Mathematician/Portfolio Managers evaluate the price of these derivatives. (Para 81 of the Order)

8. Further, it is pertinent to note that the foreign currency is neither commodity nor stock or shares. “Foreign currency” is nothing but currency printed in a different country. It is money of a country other than one’s own. “Currency” is a generally accepted form of money including coins and paper notes which is issued by a government and circulated within an economy. It is a medium based on the value of an underlying commodity. It is used as medium of exchange for goods and services. The currency value of one country with another country fluctuates according to the economic factors prevalent in those countries. Therefore holding foreign currency is placing reliance on the economic factors prevalent in that country and Stock/Shares is placing reliance in the economic strength and business policies of the company. Section 43(5) of the Act defines speculative transactions as under:-

Section 43 (Relevant provisions are highlighted herein below)

(5): “speculative transaction” means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips:

Provided that for the purposes of this clause—

(a) a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or

(b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations; or

(c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of “actual delivery”, see Taxman’s Direct Taxes Manual, Vol. 3. Jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; [or]

(d) an eligible transaction in respect of trading in derivatives referred to in clause 35[(ac)] of section 236 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognized stock exchange;]

shall not be deemed to be a speculative transaction.
Explanation.—For the purposes of this clause, the expressions—

(i) “eligible transaction” means any transaction,—

(A) carried out electronically on screen-based systems through a stock broker or sub-broker or such other intermediary registered under section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992) in accordance with the provisions of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) or the Securities and Exchange Board of India Act, 1992 (15 of 1992) or the Depositories Act, 1996 (22 of 1996) and the rules, regulations or bye-laws made or directions issued under those Acts or by banks or mutual funds on a recognised stock exchange; and

(B) which is supported by a time stamped contract note issued by such stock broker or sub-broker or such other intermediary to every client indicating in the contract note the unique client identity number allotted under any Act referred to in sub-clause (A) and permanent account number allotted under this Act;

(ii) “recognised stock exchange” means a recognised stock exchange as referred to in clause (f) of section 238 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfils such conditions as may be prescribed and notified 39 by the Central Government for this purpose;]

It is pertinent to note that banks have option to trade in foreign currency derivatives either through recognized stock exchange or through RBI. When the banks facilitates its clients to deal in foreign exchange derivatives through RBI, more stringent regulations are complied and therefore these transactions cannot be denied the benefits provided under the Act when traded through recognized stock exchange.

9. Now the question is whether to treat the foreign currency derivatives as commodities, or stocks and shares. If it is treated as commodities, Section 43(5)(a) of the Act comes to the rescue of the assessee because in the present case, the assessee is a manufacturer and exporter of garments and the assessee has entered into foreign currency derivative transactions to guard against future currency fluctuations which has a close proximity to the business of the assessee. On the other hand, if it is treated as stock /shares, such transactions will not be treated as speculative transactions if the transaction is carried out through a recognized stock exchange. The argument of the Revenue is that, if the transactions are made though banking sectors, then the same will fall within the scope of speculative transactions. This argument appears to be absurd and illogical because both Recognized Stock Exchange and Nationalized Banks are either Government regulatory body or extended arm of the Government. Further the characteristic of the currency and stock/shares are not the same and therefore, currency cannot be held as stock or shares. This view is also fortified with the various decisions.

10. Now let us examine the following decisions:-

A. In the case of CIT Vs. Badridas Gauridu (P) Ltd., reported in (2003) 261 ITR (Bom) wherein it was held that the assessee was not a dealer in foreign exchange. The assessee was a cotton exporter. The assessee was an export house. Therefore, foreign exchange contracts were booked only as incidental to the assessee’s regular course of business. The Tribunal has recorded a categorical finding to this effect in its order. The Assessing Officer has not considered these facts. Under s.43(5) of the IT Act, ‘Speculative transaction” has been defined to mean a transaction in which a contract for the purchase or sale of a commodity is settled otherwise than by the actual delivery or transfer of such commodity. However, as stated above, the assessee was not a dealer in foreign exchange. The assessee was an exporter of cotton. In order to hedge against losses, the assessee had booked foreign exchange in the forward market with the bank. However, the export contracts entered into by the assessee for export of cotton in some cases failed. In the circumstances, the assessee was entitled to claim deduction in respect to Rs.13.50 lakhs as a business loss. This matter is squarely covered by the judgment of the Calcutta High Court, with which we agree, in the case of Ld. CIT Vs. Soorajmull Nagarmull (1981) 22 CTR (Cal.) 8: (1981) 129 ITR 169 (Cal.)

B. In the case of CIT Vs. Sooraj Mull Nagarmull, reported in (1981) 129 ITR 169(Cal.) wherein it was held that the assessee used to carry on export and import of jute business. In the course of normal business it used to enter into foreign exchange contracts in order to cover up loss and difference in foreign exchange valuation. The assessee utilized part of the amount of the foreign exchange covered. This finding of fact has not been challenged, If in the course of normal carrying on of business certain loss or obligation or interest arise these must be deferrable to the carrying on of the business and these must be incidental to the carrying on of the business. Undoubtedly, the contract for foreign exchange as such can be treated as a contract for commodity. But the question here essentially is that the assessee was carrying on business of export and import of jute goods. In order to carry out these transactions, the assessee had to enter into foreign exchange contract in order to cover up these transactions. In those foreign exchange contracts, if any loss occurred then such loss was a loss referable to and related to the business carried on and arising out of the business of the assessee. Here there is no finding that entering into foreign exchange contract was the nature of the business operation for the export and import of the goods by the assessee. The assessee was not a dealer in foreign exchange contract as such. Here in this case, the contract was for a full amount and what the assessee paid in fulfillment of the obligation which was an implied term at the time of entering into the contract did not amount to breach of contract. The breach of contract did not come within the meaning of ‘contract settled’ as used in Expln.2 of s.24(1) of IT Act, 1922, ‘contract settled’ meant contract settled before breach. Where the money which the assessee paid was in settlement of the amount of damages suffered by the assessee by reason of breach of the contract to delivery, it is to be held that the payment was not a loss from a speculative transaction as defined in Expln.2 of s.24(1) of IT Act, 1922.

C. In the case of Cotton Blossoms (India) Pvt. Ltd. V ACIT, in ITA No.2032/Chny/2012 vide order dated 21.02.2013, also the Chennai Bench of the Tribunal held that, in respect of forex contracts entered into by the assessee in similar circumstances will not fall under the definition of speculative transaction.

D. In the case of Sutlej Cotton Mills Ltd Vs. CIT, reported in 116 ITR 1(SC) wherein it was held that loss on account of revaluation of foreign currency is a trading loss to the extent it does not relate to any capital asset and accordingly allowable.

E. In the case of Munjal Showa Ltd. Vs. Dy.CIT, reported in (2005) 94 TTJ (Del.) wherein it was held that profit on cancellation of forward contract in foreign currency entered into for safeguarding against loss by fluctuation in foreign currency for purchase of plant and machinery with loan obtained in foreign exchange is capital receipt and not speculative profit.

F. In the case of CIT Mumbai Vs. Vishindas Holaram, reported in (2014) taxmann.com 37(Bombay) it was held that once main business of assessee is identified, if some incidental activities or transactions or dealing in foreign exchange is undertaken but that is also related to some extent to main business activity, then, it could not be said that assessee is in speculative business.

G. In the case of CIT Vs. Climate System Pvt. Ltd., reported in 2014 (8) TMI 901 – Delhi High Court wherein it was held that exchange fluctuation arising on the revenue account transaction should be allowed as deductable expenditure.

11. Thus to sum up in the present case before us, the assessee is an exporter of garments who has entered into forex derivative transactions through its bankers with a view to effectively hedge its foreign currency risk. Therefore, these forex derivative transactions have a close proximity or rather incidental to the export business of the assessee, which cannot be considered as speculative. Moreover in the case of the assessee foreign currency contracts cannot be treated as wagering contracts for the reasons discussed herein above. Section-43(5) of the Act is applicable to transactions in commodity or stocks and shares. If currency is treated as commodity, then according to Section 43(5) (a) of the Act, such transaction shall not be deemed to be speculative transaction. Further currency cannot be treated as stock or shares because inherently they have different characteristic. Further, in the case of the assessees, the foreign exchange exposure for the “relevant period” specified by “R.B.I” regulations is quiet substantial in order to justify the forex derivative transactions made by the assessee through Government recognized channel, otherwise the RBI would not have entertained these transactions and would have restrained the banks from entering into such transaction with its clients. Thus considering the totality of the facts and circumstance of the case and the decisions relied upon herein above, we allow the grounds raised by the assessee’s on this issue for all the three appeals in favour of the assessee and accordingly we hereby direct the Revenue to set off of the losses incurred by the assessee on account of forex derivatives contracts against the business income of the assessee. Thus, the ground raised in the assessee M/s.SCM Garments Pvt Ltd in ITA Nos.1645/13 & 2275/Mds./2014 for the assessment years 2009-10 & 2010-11 and the first ground raised by the assessee M/s.Gajaananda Jewellery Maart Pvt Ltd. in ITA No.1646/Mds./2013 for the assessment year 2009-10 are allowed in their favour.”

In the present case also the assessee entered into forex exchange transaction through its banker with a view to effectively hedge its foreign currency risk therefore these forex derivative transaction are a close proximity or rather incidental to the business of the assessee which cannot be considered as speculative.

13.9 Similar view has been taken by the ITAT Chennai Bench ‘A’ in the case of DCIT Vs. Kunnam Granite Works (2022) 136 taxmann.com 415 (Supra) wherein relevant findings have been given in para 8 & 9 as under:

8. We have heard both the parties, perused the materials available on record and gone through orders of the authorities below. The facts borne out from record clearly indicated that assessee had entered into business of export of monument granite blocks to Japan Companies through their Chinese Intermediaries. The Chinese Intermediaries would be making the payment in USD with a future possibility of the direct payment by Japan customers in Japanese Yen depending on the currency fluctuation. As agreed by the parties, the assessee had achieved export sales of Rs. 50.53 Crs. for the FY relevant to the AY 2009-10. Since, the assessee had huge export receivables from customers, it had entered into a Forex derivative transaction with State Bank of India to hedge the foreign currency risk involved in these transactions. The assessee has treated profit or loss arised on account of fluctuation of foreign currency as income or expenses, as the case may be, in the relevant AYs. The Department has accepted the income declared by the assessee on account of Forex gain whenever the assessee has earned gain from appreciation in foreign currency. However, disputed loss claimed for the year under consideration only on the ground that derivative transactions entered into by the assessee is in the nature of speculative transaction, which does not come under proviso ( d ) to sec.43(5) of the Act.

9.We have gone through the reasons given by the AO to treat Forex loss incurred by the assessee on account of derivative transactions as speculative transactions in light of various arguments advanced by the Ld.AR for the assessee and we ourselves do not subscribe to the reasons given by the AO for the simple reason that the assessee being an export of goods to Japan Company had entered into hedging transactions with State Bank of India by entering into Forex derivatives to minimize possible loss in fluctuation in USD, because the Japanese Companies agreed to make the payments through their Chinese Intermediaries by USD. Further, during the year under consideration, the assessee achieved an export turnover of Rs.50.53 Crs. which is much more than the amount of derivative contracts entered into by the assessee with State Bank of India. We further noted that when the assessee enters into a hedging transaction to minimize the possible loss from fluctuation in foreign currency, then profit or loss arises on account of appreciation or depreciation in the value of foreign currency held by it on conversion into another currency, such profit or loss would ordinarily be a trading profit or loss, if the foreign currency is held by the assessee on Revenue account or as a trading asset or as a part of circulating capital embarked in the business, if the underline asset is more than the amount of forward contracts entered into by the assessee. This legal principle is supported by the decision of the Hon ble Supreme Court in the case of Woodward Governor India (P.) Ltd. (supra), and it is also supported by the principles laid down by the Hon ble Bombay High Court in the case of CIT v . VS. Dempo & Co. Pvt. Ltd. [1994] 72 Taxman 134/206 1TR 291 (Bombay), wherein, it was held that the loss arising in the process of conversion of foreign currency, which is part of trading asset of the assessee, is a trading loss as any other loss. In this case, the facts available on record clearly shows that the assessee being an export of goods had huge receivables from customers entered into a hedging contract with its bankers to minimize the possible fluctuation in foreign currency, which resulted in loss and the same has been treated as Revenue expenditure or business loss. The Ld. CIT(A) after considering the relevant facts has rightly held that loss incurred by the assessee on account of fluctuation in foreign currency, is in the nature of business loss, but not speculative loss, which is covered u/s.43(5) of the Act. Facts remain unchanged. The Revenue failed to bring on record further evidences to prove the findings of facts recorded by the Ld. CIT(A) are incorrect. Hence, we are inclined to uphold the findings of the Ld. CIT(A) and dismissed the appeal filed by the Revenue.

In the present case also the assessee entered into hedging contract with its banker i.e; ICICI Bank to minimize the possible fluctuation in foreign currency which resulted in a loss, so it was a business loss or revenue loss.

13.10 We therefore by considering the totality of the facts as discussed herein above and by respectfully following the aforesaid referred to decisions of the Coordinate Benches at different stations delete the impugned addition made by the AO and sustained by the Ld. CIT(A).

14. Next issue vide Ground No. 2 relates to the sustenance of disallowance amounting to Rs. 1,82,24,640/- made by the AO by invoking the provisions of Section 14A of the Act read with rule 8D of the Income Tax Rules, 1962.

15. The facts related to this issue in brief are that the AO during the course of assessment proceedings noticed that the assessee had earned dividend income of Rs. 60,03,156/- which had been claimed to be exempt under section 10(34) of the Act. The assessee had worked out a sum of Rs. 66,419/-as disallowance under section 14A of the Act. The AO also observed that the assessee apart from manufacturing & export was also engaged in making investment in quoted and unquoted shares from year to year. He asked the assessee to explain as to why provisions under section 14A of the Act should not be applied.

15.1 In response, the assessee submitted as under:

During the year under consideration the assessee company has earned exempt income u/s 10 (34) comprising of dividend income of Rs. 6,003,156/- The investment made during the year as well as in earlier year was made from current accruals, reserves and surplus available with the company. Your kind self would appreciate that sufficient funds in the form of reserves were available with the company to make the investments. No specific amount was borrowed for the purpose of making investments.

However, some expenses are attributable for earning the said – dividend income of Rs. 6,003,156/-. Accordingly the assessee itself the disallowance u/s 14A as Rs. 66,419/- and added in its return on the principle as laid down by the Hon’ble ITAT in CO.No. 17/2001 for Asstt.Year 1997-98 in case of Nahar Industrial Enterprises Ltd one of the group company and also followed by your predecessor in Assessment proceedings for Asstt. Year 2006-07. The calculation is given as under.

On the basis of the above computation the assessee company has already added back Rs. 66,419/- u/s 14A of the IT. Act. The principle of proportion has been approved by the Hon’ble Bombay High Court in the case of Godrej & Boyce Manufacturing Co.

The assessee further submits that the Hon’ble Bombay High Court in the case of Godrej & Boyce Manufacturing Co has held that the expenses relatable to income which do not become part of total income, has to be apportioned on the basis of taxable income & non taxable income. The Bombay High Court has relied upon the decision & principles laid down by Hon’ble Supreme Court in the case of C.I.T V/s WALFORT SHARE & STOCK PVT. LTD reported in 233 CTR – 42 (ST). The assessee itself has computed the disallowance on the basis of proportion as mentioned by the Apex Court & Bombay High Court. Rule 8 D can be applied only in the cases where the assessing officer is not satisfied with the disallowance made by the assessee on the basis of expenditure shown in the books. In our case the expenditure to be disallowed u/s 14A has been rightly computed as approved by the courts in the cases mentioned above. You are therefore requested not to apply Rule 8D in our case.

However, without prejudice to the above submissions and as desired computation of disallowance u/s 14A as per rule 8D of the Income Tax Act is enclosed.”

15.2 The AO also observed that the assesee company had computed the disallowance by taking the proportionate of operating income and dividend earned, but only administrative expenses had been proportionately divided. In support of its computation, the assessee submitted that computation was based upon the principle laid down by the ITAT in the case of M/s Nahar Industrial Enterprises Ltd., a group company for the A.Y. 1997-98 and the same had been accepted by the Department for the A.Y. 2006-07. It was also emphasized that the same principle had been accepted by the Hon’ble Bombay High Court in the case of Godrej Boyce Mfg. Co. Ltd. and Hon’ble Apex Court in the case of CIT Vs. Walfort Share & Stock Pvt. Ltd. reported at 233 CTR 42.

15.3 After considering the submissions of the assessee, the AO observed that the computation of disallowance had not been made correctly by the assessee, he worked out the disallowance by invoking the provisions of Section 14A of the Act read with rule 8D of the Income Tax Rules in the following manner:

15.4 The assessee objected to the working of the AO and submitted as under:

“With reference to the subject mentioned above and queries raised at Sr.No.3 vide questionnaire dated 18.12.2013, regarding disallowance u/s 14A read with rule 8D by considering total interest paid (including interest on working capital as well as term loan) it is humbly submitted as under:.

That the assessee on its own while computing disallowance u/s 14A had considered proportionate interest attributable to investments. The balance amount of interest pertains to the loan of Rs. 177.12 Cr taken by company by way of term loan and Rs. 199.38 Cr for working capital. As against the total term loan of Rs. 199.38 Cr. my fixed block of assets was Rs. 300.98 Cr. which is sufficient to demonstrate the utilization of entire term loan far-purchase of fixed assets. Besides, please note that entire term loan is taken under tuff scheme as is evident from page 14 of Balance Sheet, which under no circumstances can be utilized for any other purposes except for fixed assets of textile unit spelt out under tuff scheme.

Further during the year under consideration the company’s total borrowed working capital loan is Rs. 199.38 Cr. and against which current assets of the company, which entitles the company to borrow from bank, is Rs. 377.67 Cr.. According to the net current asset ratio, working capital and the current ratio should be 1:1.33 so long as this ratio is satisfied obviously there cannot be any other inference than that money borrowed from bank have been invested in working capital for the purposes of business.

The complete detail of current assets as against working capital loan is as under:

In view of above it is clear that the interest paid on term loan and working capital was for the purpose of income earned which is subjected to tax. The interest paid to others has been apportioned for computing disallowance u/s 14A. Further, it is submitted that investments during the year under consideration has reduced to 29.05 Cr. from 58.09 Cr. of the immediately preceding year which can be verified from pages 16 & 17 of. the printed balance sheet. The fresh investments made during the year are out of the proceeds of the investments sold during the same year. Further, the investments made in the earlier years were made from net internal accruals and Reserves & Surplus of Rs. 251.07 Cr. available with the company which are sufficient to justify the investments made by the company there from.

Further, without prejudice to the above submissions the disallowance u/s 14A with respect to Rule 8D if, any, is to be calculated, then, interest on working capital as well as interest on term loan, should not be taken in to account as these relates to business receipts which are subjected to tax. Further, also only those investments be considered on which the assessee has received the exempt income and not other investments on which no exempt income have been received by the assessee company as held by Hon’ble Calcutta ITAT in the case of REI Agro reported in 144 ITR-141 (Cal).”

15.5 The AO however was not satisfied with the correctness of the claim of the expenditure made by the assesee in relation to the income which does not form part of the total income by observing that the method adopted by the assessee could not be accepted because it had been worked out upon administrative expenses only on proportionate basis and a part of interest paid only, however, the expression of “expenditure incurred” in section 14A of the Act refers to other expenditures also including rent, taxes, salaries, interest etc. which can’t be apportioned unless Rule 8D is applied. The AO referred to the judgment of the Hon’ble Apex Court in the case of CIT Vs. V.W. Alfort Share Brokers P. Ltd. reported at 326 ITR 1 and in the case of Godrej and Boycee Mff. Co. Ltd. as well as the judgment of Hon’ble P&H High Court in the case of CIT Vs. Punjab State Industrial Development Corp. Ltd. in ITA No. 565 of 2006 vide order dt. 18/07/2011. The reliance was also placed on the decision of the ITAT Chandigarh Bench in the case of Sigma Cartons (P) Ltd. Ludhiana Vs. Department of Income Tax in ITA No. 769/Chd/2011 vide order dt. 10/07/2012 for the A.Y. 2008-09.

15.6 The AO observed that this submissions of the assessee that the entire term loan had been invested for the purchase of assets was not correct because the assessee had to contribute its own funds for investment in assets and normally the financial institutions finance only the remaining part. The AO pointed out that the total term loan during the year was of Rs. 177.12 crore and the total share capital and reserves were of Rs. 275.97 crores i.e; Rs. 453.09 crores where as the gross block was of Rs. 516.75 crores. He was of the view that normally the interest free funds available with the assessee would have been invested in the fixed assets and nothing was left for investment in shares except the interest bearing funds i.e working capital loan and other unsecured loans. According to the AO the disallowance on this account came to Rs. 1,82,24,640/-and as the assessee had already disallowed a sum of Rs. 66,419/- in the computation of income, further disallowance of Rs. 1,81,58,221/- was made under section 14A of the Act.

16. Being aggrieved the assessee carried the matter to the Ld. CIT(A) and submitted that the application of Rule 8D in the assessee’s case was not justified as the assessee had itself worked out the disallowance under section 14A of the Act on the basis of well recognized method of proportion i.e; dividend income vis-à-vis operating income which had been upheld by the ITAT Chandigarh Bench in other group company cases. It was further stated that for the purpose of Rule 8D, only the interest which was not directly attributable to any particular income or receipt was to be taken for calculating the disallowance under the said Rule. It was also stated that the total amount of term loan was duly utilized in the block of assets i.e; the purpose for which it was raised and the working capital borrowed was also used for the purpose of business. It was stated that the disallowance should not exceed the amount of exempt income claimed by the assessee.

16.1 The Ld. CIT(A) forwarded the submissions of the assessee to the AO who vide his report dt. 19/09/2014 reiterated the findings recorded in the assessment order and contended that the disallowance was justified, reference was also made to the decision of the Hon’ble Punjab & Haryana High Court in the case of M/s Avon Cycles Ltd. Vs. CIT in ITA No. 277 of 2013 order dated 20/08/2014. The Ld. CIT(A) provided the report of the AO to the assesse who furnished the written submission dt. 17/11/2014 which had been incorporated at page no. 20 of the impugned order by the Ld. CIT(A) for the cost of repetition the same is not reproduced herein.

16.2 The Ld. CIT(A) after considering the submissions of the assessee and report of the AO sustained the disallowance and observed that the assessee had not been able to establish that these investments were actually made out of interest free funds and no amount of interest bearing funds were used for this purpose and that the assessee had not shown any direct nexus of borrowed funds with any particular income or expenditure as there was mixed use of borrowed funds and it was not possible to link the borrowed funds with any particular income or receipt. He therefore held that there was mixed use of interest bearing funds and that some of the funds were used for investment in business while a part of the funds was used towards investment in shares. As such Rule 8D(ii) was attracted in the assessee’s case. The Ld. CIT(A) held that the provisions of Section 14A of the Act r.w.r 8D would be applicable, the reference was made to the following case laws:

•  Avon Cycles Ltd. Ludhiana Vs. CIT, Ludhiana in ITA No. 277 of 2013 vide order dt. 20/08/2014 (P&H)
•  Avon Cycles Ltd. in ITA No. 1143/Chd/2011 vide order dt. 17/01/2013 (Chd Trib)
•  CIT Vs. Reliance Utilities and Power Ltd. (2009) 313 ITR 340
•  CIT Vs. Hero Cycles Ltd. (2010) 323 ITR 518 (P&H)
•  Anil Kumar Singhania Vs. ACIT in ITA Nos. 1349 & 1350/Chd/2012 vide order dt. 08/08/2014 (Chd Trib)
•  DCIT, Circle-1, Ludhiana Vs. Sunder Forging in ITA No. 803/Chd/2011 vide order dt. 17/05/2012 (Chd Trib)
•  JCIT (OSD) Circle-1, Ludhiana Vs. Sunder Forging in ITA No. 1059/Chd/2011 vide order dt. 17/05/2012 (Chd Trib)
•  ACIT, C-V, Ludhiana Vs. Sigma Cartons(P) Ltd. in ITA No. 769/Chd/2011 vide order dt. 10/07/2012 (Chd Trib)
• CIT Vs. Walfort Share & Stock Brokers(P) Ltd. (2010) 326 ITR 1 (SC)
•  ACIT C-V, Ludhiana Vs. M/s Chadha Super Cars P. Ltd., in ITA No. 36/Chd/2012 vide order dt. 28/12/2012 (Chd Trib)
•  M/s Chadha Super Cars P. Ltd., Vs. ACIT C-V, Ludhiana in ITA No. 1241/Chd/2011 vide order dt. 28/12/2012 (Chd Trib)
•  HSBC Invest Direct (India) Ltd. Vs. DCIT, Range 8(ii) in ITA No. 3485 & 3944/Mum/2012 vide order dt. 17/10/2014 (Chd Trib)
•  M/s Munjal Castings Vs. ACIT in ITA No. 774/Chd/2012 vide order dt. 15/09/2014 (Chd Trib)

16.3 The Ld. CIT(A) held that the AO was fully justified in holding that the provisions of section 14A of the Act were applicable in the case of the assessee and disallowance was required to be made under Rule 8D of the Income Tax Rule. As regards to this contention of the assessee that the disallowance under section 14A of the Act should not exceed the amount of exempt income, the Ld. CIT(A) observed that there was no such proposition that the disallowance of expenditure under section 14A of the Act cannot exceed the exempt income earned and that the legislature had provided Rule 8D for computation of disallowance under section 14A of the Act which does not provide for any such limit.

17. Now the assessee is in appeal.

18. The Ld. Counsel for the assessee reiterated the submissions made before the authorities below and submitted that the assessee during the year under consideration had earned dividend income of Rs. 60,03,156/- which had been claimed to be exempt under section 10(34) of the Act and that the assessee had worked out a sum of Rs. 66,419/- as disallowance under section 14A of the Act. It was further submitted that the AO worked out the disallowance at Rs. 1,82,24,640/- under section 14A of the Act by erroneously applying the provisions of Rule 8D by including the interest paid on term loan which alongwith interest was attributable to and / or relatable directly to business of the assessee and further the AO instead of taking into consideration the average investment from which the exempt dividend income was received during the year under consideration total average investment as shown in the balance sheet which pertained to the earlier A.Y. including the present A.Y. from which no dividend income had been earned. It was stated that the investment had been reduced during the year under consideration on the reserves and surplus were made as per the balance sheet therefore the presumption was raised as per the various decisions of the Hon’ble High Court including that a jurisdictional High Court in the case of CIT Vs. Max India Ltd. reported at (2016) 388 ITR 81 (P&H) wherein it was held that no disallowance under section 14A of the Act could be made of any expense by applying Rule 8D.

18.1 It was submitted that the assessee earned exempt dividend income of Rs. 60,03,156/- under section 10(34) of the Act from past investments made during the earlier years. The said fact could be deduced and got supported from the findings recorded by the AO in para no. 4 of the assessment order wherein it has been mentioned that the total investment as on 31/03/2011 was Rs. 29.04 Crores as shown in the balance sheet against Rs. 58.09 Crores in earlier years which clearly shows that the investment had been reduced substantially during the year under consideration. It was further submitted that the funds available with the assessee company as on first day of the previous year were of Rs. 194.06 Crores as per the balance sheet on the assessment records, therefore, in view of the settled principles of law that where the assessee received dividend by way of exempt income from the investments made in the earlier years from interest free funds (own funds) available with the assessee and such own funds were much larger as compared to investment, the disallowance by applying the provisions of section 14A of the Act would be erroneous and unsustainable.

18.2 It was contended that as against the addition made under section 14A of the Act read with rule 8D of the Income Tax Rule 1962 by the AO and sustained by the Ld. CIT(A) to the tune of Rs. 1,81,58,221/- , the assessee worked out disallowance on proportionate basis to the tune of Rs. 66,935/- in respect of dividend income of Rs. 60,03,156/-. It was pointed out that in the preceding assessment year out of the total dividend income of Rs. 1.06 Crores earned by the assessee disallowance on proportionate basis had been worked out at an amount of Rs. 1,33,928/- and the ITAT vide order dt. 03/07/2019 in the appeal for the said assessment year asked the AO to work out the disallowance at an amount of Rs. 9,36,183/- after taking into consideration administration expenses which had not been taken into consideration by the assessee in view of the fact that none of the lower authorities pointed out any defect in the computation of proportionate disallowance computed by the assessee. It was stated that the issue under consideration is squarely covered vide order dt. 03/07/2019 for the A.Y 2010-11 in ITA No. 37/Chd/2015 in assesse’s own case, copy of the said order is placed at page no. 38 to 46 of the assessee’s compilation. The reliance was placed on the following case laws:

• The South Indian Bank Ltd. Vs. CIT reported at 438 ITR 1 (SC)
• Canara Bank Vs. ACIT, Bangalore [2014] 265 CTR 385 (Karnataka)

19. In his rival submissions the Ld. CIT DR reiterated the observations made by the AO in the assessment order and strongly supported the said order. The Ld. CIT DR also reiterated the observations made by the Ld. CIT(A) in para 4.6 of the impugned order wherein the Ld. CIT(A) had observed that the assessee had not been able to establish that the investments were actually made out of the interest free funds and no amount out of interest bearing funds was used for this purpose and that the assesse had not shown any direct nexus of borrowed funds with any particular income or expenditure. It was further submitted that the Ld. CIT(A) was fully justified in upholding the view of the AO that the provisions of Section 14A were applicable in this case and disallowance was required to be made under Rule 8D.

20. We have considered the submissions of both the parties and perused the material available on the record. It is noticed that the assessee during the year under consideration had recived exempt dividend income of Rs. 60,03,156/-, the assessee had received the said dividend income through RTGS. while the AO disallowed the amount of Rs. 1,82,24,640/- by invoking the provision of section 14A of the Act read with rule 8D of the Income Tax Rule and the assessee itself disallowed a sum of Rs. 66419/- which had been accepted by the Ld. CIT(A).

20.1 On a similar issue the Hon’ble Karnatakak High Court in the case of Canara Bank Vs. ACIT, Bangalore (supra)held in para 12 of the said order as under:

“12. In the instant case, facts set out above demonstrates the income is derived by the dividends u/s. 10[33] of the Act and interest on tax free bonds u/s. 10[15][h] of the Act and interest on long term finance to infrastructure companies u/s. 10[23G] of the Act. In other words, the persons with whom the amounts are invested by the assessee are crediting the aforesaid amount to the assessee’s account by way of a bank transfer. Therefore, no human agency is involved in collecting these dividends and interest for which the assessee has to incur any expenditure. This is the consequence of computerization, online transaction through NEFT [National Electronic Fund Transfer], RTGS [Real Time Gross Settlement] and also DEM AT Accounts. The assessing authority should take note of these developments in deciding whether any expenditure is incurred in earning the said income. The discussion by the assessing authority clearly demonstrates these aspects has not been taken note of and the notional expenditure is calculated pre-modernization. Therefore, in the light of the aforesaid judgment, when the assessee has not incurred any expenditure for realizing this income, the question of holding that 2% of the gross total income is an expenditure and that has to be added back to the income is unsustainable in law. Accordingly, the substantial question of law is answered in favour of the assessee and against the revenue. “

20.2 On a similar issue the Hon’ble Apex Court in the case of South Indian Bank Vs. CIT[2021] 438 ITR held as under:

(i) That if investments in securities were made out of common funds and the assessee had available, non-interest-bearing funds larger than the investments in tax-free securities, disallowance under section 14A could not be made. An assessee definitely has the obligation to provide full material disclosures at the time of filing of the return but there is no corresponding legal obligation upon the assessee to maintain separate accounts for different types of funds held by it. There was no statutory provision which obligated the assessee to maintain separate accounts which might justify proportionate disallowance. The nexus between expenditure disallowed and earning of exempt income had not been established. The disallowance under section 14A of the Act for the investment made by the assessee in bonds and shares using interest-free funds, would be legally impermissible.”

20.3 In the present case also the assessee had made the investment in the securities out of common funds, the assessee was also having non interest bearing funds, even there was reduction in the investment during the year under consideration. The assessee also claimed to have received the dividend income through RTGS, therefore the disallowance made by the AO was not justified. It is also noted that a similar issue having identical facts was a subject matter of the assesse’s appeal for the preceding assessment year 2010-11 in ITA No. 37/Chd/2015 wherein vide order dt. 03/07/2019 it has been held as under:

6. So far as the administrative expenses are concerned, the assessee has given a scientific formula for calculating the disallowance out of administrative expenses. However, we find that the assessee while taking the total administrative expenses has not considered the personal expenses and other allowances. The authorized representative of the assessee, before us, has submitted another chart, wherein, the personnel expenses and other allowances have been included and thereby the proportionate of disallowance out of administrative expenses has been computed as under:-

7. None of the lower authorities have pointed out any defect in the computation of proportionate disallowance computed by the assessee except that certain part of the administrative expenses were not taken into consideration which has been taken into consideration in the computation made above.

Even the assessee has claimed that it has not incurred any administrative expenses for earning of tax exempt income. The Assessing Officer in this respect has not recorded any dissatisfaction taking into consideration the accounts of the assessee. The Hon’ble Bombay High Court in the case of ‘Godrej & Boyce Manufacturing Co.’ 328 ITR 81 has held that under section 14A of the Act, resort can be made to Rule 8D of the Income Tax Rules for determining the amount of expenditure in relation to exempt income, if, the AO is not satisfied with the correctness of the claim made by the assessee in respect of such expenditure. The satisfaction of the Assessing Officer has to be arrived at, having regard to the accounts of the assessee. Sub section (2) does not ipso facto enable the Assessing Officer to apply the method prescribed by the rules straightaway without considering whether the claim made by the assessee in respect of such expenditure is correct. The satisfaction of the Assessing Officer must be arrived at on an objective basis. In a situation where the accounts of the assessee furnish an objective basis for the Assessing Officer to arrive at a satisfaction in regard to the correctness of the claim of the assessee, there would be no warrant for taking recourse to the method prescribed by the rules. An objective satisfaction contemplates a notice to the assessee, an opportunity to the assessee to place on record all the relevant facts including his accounts and in the event that he comes to the conclusion that he is not satisfied with the claim of the assessee. We may further observe that the Hon’ble Delhi High Court in a recent decision has further given a similar view in the case of “CIT vs. Taikisha engineering India Ltd. ” (supra) and has held that the AO having regard to the accounts of the assessee is required to record his satisfaction that the self or voluntarily expenditure offered by the assessee or claim that no expenditure has been incurred by the assessee in relation to earning of exempt income was not correct or the same was unsatisfactory on examination of the accounts of the assessee. Without recording such a satisfaction, he cannot proceed to apply Rule 8D for the computation of disallowance under section 14A. However, as observed above, in the case in hand, the Assessing officer has not followed the guidelines of objective satisfaction as laid down by the Hon’ble Bombay High Court in the case of ‘Godrej & Boyce’ (supra) while making the disallowance. Neither the Assessing Officer nor the Ld. CIT(A) has pointed out any defect in the working given by the assessee in computing suomotu disallowance except that a certain part of tax relating to the personnel expenditure and other allowances were not taken into consideration. In the working given before us, as reproduced above, whereby, the proportionate amount of disallowance of expenditure to earn dividend income has been computed at Rs. 9,36, 183/- by including the personnel expenditure and certain other expenses, as noted above. In view of this, the disallowance of administrative expenses is restricted to Rs. 9,36, 183/-. However, the assessee will get the benefit /set off at the suomotu disallowance offered by the assessee in the return of income at Rs. 1,33,928/- and accordingly the addition is restricted to Rs. 8,02,255/-.

In view of our findings given above, the appeal of the assessee is treated as partly allowed.

20.4 For the year under consideration also the assessee had given calculation at page no. 20 of the submission dt. 17/02/2020 as under:

A. Disallowance u/s 14A on proportionate basis as per Order of Hon’ble ITAT in Assessee’s case

	Assessment Year 2011-12 (Amount in Rs.)
1.  Amount of dividend income	60,03,156
2.  Operating Income	961,25,89,314
3.  % of dividend	0.06245
4.  Amount of expenses	70,31,00,532
5. Proportionate amounts of disallowance of expenses to earn dividend	4,39,093
Detail of Expenses	3,46,88,260
a) Interest paid to others
b) Administrative expenses	16,13,33,459
c)  Personal expenses & other allowances	50,70,78,613
Total	70,31,00,532

20.5 We therefore respectfully following the earlier order dt. 03/07/2019 of the ITAT in assessee’s own case for the A.Y. 2010-11 direct the AO to verify the calculation made by the assessee vis a vis the calculation made in the earlier year which were accepted by the ITAT and restrict the disallowance accordingly to Rs. 4,39,093/- and since the assessee had already disallowed a sum of Rs. 66,419/- under section 14A(1) of the Act, the said amount is to be reduced and the remaining amount may only be disallowed. Accordingly this ground of the assessee’s appeal is partly allowed.

21. The next issue vide Ground no. 3 relates to the sustenance of disallowance of Rs. 1,53,17,042/- out of the interest paid on working capital loan and long term loan.

22. The facts related to this issue in brief are that the AO during the course of assessment proceedings noticed that the assessee company was engaged in making investment in quoted and unquoted shares from year to year apart from manufacturing & export. And during the year under consideration the assessee had shown in the balance sheet, investment of Rs. 29.04 crores as on 31/03/2011 as against Rs. 58.09 crores in earlier years. The AO asked the assessee to explain as to why interest in investment in shares etc should not be allocated and made part of cost and disallowed under section 36(1)(iii) of the I.T. Act. In response the assessee submitted as under:

“Regarding this query in respect of disallowance of interest u/s 36(l)(iii). It is submitted that the total investments as on 31.03.2011 were Rs. 29.05 Cr. as against Rs.58.09 Cr. of last year as is apparent from the schedule VI of the printed balance sheet at Pages 16 & 17. Fresh Investments made during the year of Rs. 11.57 Cr were made out investments sold in the same year. Hence, no investment was made out of fresh funds, during the year.. The investment made in earlier years were from the sufficient funds out of internal accruals and own funds available with the company. The amount of interest on term loan and working capital limit debited in financial expenses are not attributable to long term, investment. These amounts of loan was directly utilized for the purpose of business for which the loans were obtained. This fact is obvious from the figures of term loan as well as the investment in fixed assets by the company. Your kind self would observe from the balance sheet at page 14 that during the year term loan was Rs. 177.12 Cr. as against Rs. 147.49 Cr. for the immediately preceeding year As against the term loan, my block assets is Rs. 300.98 Cr. (please see page 11 of balance sheet), which is sufficient to demonstrate the utilization of entire term loan for purchase of fixed assets. Besides, please note that the entire term loan is taken for purchase of fixed assets which under no circumstances can be utilized for any other purposes except for fixed assets.

Further during the year under consideration, the company’s total borrowed working capital is Rs. 199.38 Cr. and against which current assets of the company which entitles company to borrow from bank is Rs.377.67 Cr. According to the net current asset ratios, working capital and current ratio should be 1:1.33 so long as this ratio is satisfied obviously there cannot be any other inference than that money borrowed from bank have been invested in working capital for the purpose of business. The complete detail of current assets as against working capital loan is as under.

Inventory   – Sundry Debtors  –	264.83 Cr. 140.24 Cr.
Cash & Bank balance     –	37.04 Cr.
	442.11 Cr
Loans & Advances   –	118.05 Cr.
	560.16 Cr.
Less: Current liabilities &, Provisions           –	182.49 Cr.
Net current assets     –	377.67 Cr.
Working Capital Loans-	199.38 Cr.	1.89:1

In view. of above it is clear that. interest paid on term loan and working capital is for the purpose of its regular business. This fact has also been demonstrated through a computation (copy enclosed) filed vide letter dated 28.2.2014.

From the said chart you would appreciate that company was having sufficient funds to make investment of Rs. 29.05 Cr.

Further without prejudice, it is submitted that your kind self has already proposed to consider interest expenses for the purpose of disallowance u/s 14A read with rule 8D. No disallowance of the same amount can be made under two different sections. The Hon’ble legislative in its wisdom has categorically stated in Section 14A not to allow any expenses which are relatable to exempt income. The exempt income is derived from investments. That was the reason that amount of interest which is to be considered relatable to investments from where exempt income is derived, is to be considered for disallowance. You would appreciate that intention of Hon’ble Legislature is very clear that any element of interest which is relatable to investment / exempt income are to be considered for the purpose of disallowance.

It is therefore humbly prayed that no disallowance u/s 36(l) (iii) should be made on the basis of presumption, surmises & conjecture, especially when there is no fresh investment made by the assessee during the year. More so when the amount of interest is being considered for disallowance under a particular section u/s 14A of the Act.”

22.1 The AO however did not find merit in the aforesaid submissions of the assessee and observed that interest on any fund utilized for the purpose of long term investment was not allowable under section 36(1)(iii) of the Act. He further observed that the assessee had made a general statement that the term loan had been utilized for the purpose of fixed assets or the borrowing for the purpose of working capital had been utilized for the net current asset which was not sufficient to demonstrate that the assessee had utilized its own funds for the purpose of investment in shares and that the onus was on the assessee to demonstrate that the internal accruals had been utilized for the purpose of investment in shares. He also observed that the figures appearing in the balance sheet were as on particular day i.e; 31st March, so, it could not be presumed that the same state of affairs existed for the whole financial year. According to him there was no linkage on the day of making investment in shares as regards the position of cash available with the assessee i.e; with reference to own funds or borrowed funds.

22.2 The AO referred to the judgment of the Hon’ble Punjab & Haryana High Court in para 5.9 to 5.10 of the assessment order dt. 21/03/2014 in the case of Abhishek Industries Limited, reported at 286 ITR 1 and the decision of ITAT Chandigarh Bench in the case of Umesh Trehan in ITA No. 1022/Chd/2012 and M/s Vishal Coaters Pvt. Ltd. in ITA No. 281 & 282/Chd/2013. The AO also referred to the judgment of the Hon’ble Kerala High Court in the case of CIT Vs. Smt. Leena Ramchandran reported at 339 ITR 296 and of the Hon’ble Karnataka High Court in the case of Dhanuka & Sons Vs. CIT, reported at 339 ITR 319. The AO did not accept this submissions of the assessee that no interest was attributable to investment in shares and that the term loan had been invested for the purchase of assets. He opined that firstly the assessee had to contribute its own funds for investment in assets and the financial institution finance only the remaining part.

According to him the investment in gross block of assets was more than the share capital and reserves as well as the term loan. He pointed out that the total term loan during the year were at Rs. 177.12 crores and total share capital and reserves were at Rs. 275.97 crores totaling to Rs. 453.09 crores whereas the gross block was Rs. 516.75 crores. According to him interest free funds available with the assessee i.e; share capital and reserves had already been invested in the fixed assets and nothing was left for investment in shares except the interest bearing funds i.e; working capital loan and other unsecured loans. He was of the view that the assessee had made investment in shares only out of the working capital and unsecured loans on which interest had been paid. Therefore entire amount of interest attributable to investment could have been disallowed under section 36(1)(iii) of the Act. He also observed that the assessee had failed to submit any evidence to prove that investment in shares had been made out of interest free funds, at the same time the AO observed that keeping in view the assessee’s submissions that it had also made investment in the shares out of its own capital, the interest attributable to investment was to be worked out by applying the debt equity ratio. The AO observed that the total debt of the assessee were at Rs. 416.36 crores and equity including reserve and surplus was Rs. 275.97 crores and the debt equity ratio came to 60:40. The AO worked out the interest allowable to investment in shares by applying the debt equity ratio, at Rs. 3,13,63,200/-. The AO also held that the interest component which had not been allowed under section 36(1)(iii) of the Act, being funds utilized for non business purposes, exceeds the amount of interest disallowed under section 14A of the Act read with rule 8D of the Income Tax Rules 1962. The said excess component amount would go to form the cost of shares which was allowable under section 48 of the Act. The reliance was placed on the following case laws:

* Felspar Credit and Investment (P) Limited. Vs. CIT 346 ITR 121 (Madras)

* CIT Vs. Trishul Investments Limited 305 ITR 434 (Madras)

* Sunena Garg, Chandigarh Vs. DIT vide order dt. 13/05/2011 in ITA No. 543/Chd/2010 (Chd Trib)

* CIT Vs. Maithreyi Pai 152 ITR 247 (Kar.)

22.3 The AO made the disallowance of Rs. 1,53,17,042/- under section 36(1)(iii) of the Act by observing in para 5.15 of the assessment order as under:

5.15 In view of the case laws cited above Interest attributable to investment in shares would be part of its cost u/s 48(ii) of the I.T. Act. Average investment in shares is Rs.43:56 crores. Interest allocable to investment in shares applying the. debt equity ratio comes to Rs.3,13,63,200/-. Interest attributable to investment in shares has also been worked out in disallowance u/s 14A of the I.T. Act r.w. Rule 8D of the I.T. Rules to the extent of Rs.l ,60,46,158/-. The difference of Rs. 1,53,17,042/- is allocated to investment in shares and made part of its cost u/s 48(ii) of the I.T. Act. The sum of Rs.l,53,17,042/- is disallowed u/s 36(l)(iii) of the I.T. Act in the working of income from business and profession. It is worthwhile to emphasise that affectively there is no disallowance as the assessee will get benefit of increased cost of shares when these would be sold out and offered to tax under head capital gains.

23. Being aggrieved the assessee carried the matter to the Ld. CIT(A) and submitted that the AO had already proposed to consider the interest expenses for the purpose of disallowance under section 14A of the Act read with Rule 8D of the Income Tax Rules, 1962, therefore, no disallowance of the same amount could be made under two different sections. It was stated that no borrowed funds were used for making investment in the share and the interest paid on term loan and working capital loan was for the purpose of business of the assessee. The assessee also furnished a written submission which had been incorporated by the Ld. CIT(A) in para 6.3 of the impugned order which read as under:

“It is submitted that during the year the total investment in shares of Rs. 140.86 Cr. was reduced from 141.17 Cr. of the immediately preceding year. No fresh investments were made during the year. The investment made in earlier year was from the funds sufficiently available out of internal accruals and Company’s own funds. The detailed submissions were given in this regard vide our letter dated 14.03.2014 enclosed as Annexure-V, which was also reproduced by the assessing officer in its order at page 30 & 31. It was also submitted before Id. Assessing Officer that the interest expenses have also been considered for the purpose of disallowance u/s 14A of the Act. No disallowance can be made under two different sections.

The Hon ‘ble legislative in its wisdom has categorically stated in Section 14A not to allow any expenses which are relatable to exempt income. The exempt income is derived from investments. That was the reason the amount of interest which is to be considered relatable to investments from where exempt income is derived, is to be considered for disallowance. You would appreciate that intention of Hon’ble Legislature is very clear that any element of interest which is relatable to investment/exempt income are to be considered for the purpose of disallowance.

Moreover the formula adopted by the assessing officer is totally wrong because debt equity ratio of the current year cannot be taken for the purpose of disallowance. The appellant has already discharged its onus by demonstrating the figures from the balance sheet that company had sufficient funds available with it.

It is humbly prayed that addition made by Ld. Assessing Officer u/s 36(l)(iii) at Rs. 5,98,87,308/- may be directed to be deleted, especially when the interest on the amount presumed to be invested in shares from borrowed funds has been considered in disallowance u/s 14A o f the Act. “

23.1 Copy of the aforesaid submission were forwarded to the AO by the Ld. CIT(A), in response the AO vide his report dt. 18/09/2014 submitted as under;

“The AO has made an addition of Rs. 5,98,87,308/- u/s 36(l)(iii) of the I.T. Act, 1961. I have gone through the assessment order passed by the AO vide order dated 21.03.2013. The perusal of the order shows that the AO has discussed in detail in Para 6 of assessment order. The AO has mentioned in assessment order that the assessee’s argument that the said amount was utilized from own money is incorrect. Hence kindly decide this ground of appeal on basis of these facts and taking into consideration the assessment order after rejecting the submission of the assessee. “

23.2 The Ld. CIT(A) after considering the submission of the assessee and the report of the AO observed that the assessee had made a general statement that the investment had been made out of internal accruals and own funds which was not sufficient to demonstrate that the assessee had utilized its own funds for the purpose of investment in share and that there could not be a presumption that internal accruals had been utilized for the purpose of investment in shares. The Ld. CIT(A) further observed that the onus was on the assessee to demonstrate that the internal accruals had been utilized for the purpose of investment in shares and that the figures appearing in the balance sheet were as on a particular day i.e; 31st March, so, it could not be presumed that the same state of affairs existed for the whole financial year and that it was incumbent upon the assessee to get verified from the bank statement that the assessee had not utilized borrowed funds for the purpose of investment in shares, and that there was no linkage on the day of making investment in shares as regards the position of cash available with the assessee i.e; with reference to the own funds or borrowed funds. The Ld. CIT(A) referred to the judgment of the Hon’ble Punjab & Haryana High Court in the case of M/s Abhishek Industries Limited, 286 ITR 1. A reference was also made to the following case laws :

•  Umesh Trehan in ITA No. 1022/Chd/2012 (Chd Trib)
•  Vishal Coaters Pvt. Ltd. in ITA No. 281 & 282/Chd/2013 (Chd Trib)
•  CIT Vs. Smt. Leena Ramchandran, 339 ITR 296 (Kerala)
•  Dhanuka & Sons Vs. CIT, 339 ITR 319 (Karnataka)
•  ACIT Vs. M/s Kisco Casting, Proprietor Circle, M/s Khanna Iron and Steel Corpn Khanna in ITA No. 32/Chd/2011 (Chd Trib) dt. 26/06/2011
• M/s Jamna Auto Industries Ltd. Vs. JCIT in ITA No. 438/Chd/2011 dt. 04/01/2012 (Chd Trib)
• DCIT Vs. M/s Jamna Auto Industries Ltd. in ITA No. 418/Chd/2011 dt. 04/01/2012 (Chd Trib)

23.3 The Ld. CIT(A) sustained the addition made by the AO by observing in para 6.17 of the impugned order which read as under:

“ 6.17 The appellant has contended that the interest expenses have also ben considered for the purpose of disallowance u/s 14A of the Act and that no disallowance can be made under two different sections. I don’t agree with this contention of the appellant, the AO has clearly pointed out in the assessment order that infact there was no disallowance as such u/s 36(i)(iii) and it wasa mere case of re-allocation of interest expenditure on different heads.”

23.4 He also held that the disallowance made under section 14A of the Act was telescoped with reallocation of the expenses towards the cost of shares so there was no double disallowance made by the AO. Accordingly the disallowance made by the AO was confirmed.

24. Now the assessee is in appeal.

25. The Ld. Counsel for the asessee reiterated the submissions made before the authorities below and further submitted that the addition made by the AO under section 36(1)(iii) of the Act was not sustainable and that no such addition was made from the assessment years 2014-15 onwards in the case of the assessee itself by the AO. A reference was made to the page nos. 54 to 108 of the assessee’s paper book which are the copies of the assessment orders for various A.Y’s from 2014-15 onward. It was further stated that no fresh investment had been made by the assessee during the year under consideration and no interest expenditure had been incurred on account of investment in shares. It was stated that an identical issue has been decided by the ITAT Bench “B” Chandigarh in ITA No. 1341/Chd/2016 for the A.Y. 2012-13 in the case of the group companies i.e; M/s Monte Carlo Fashions Ltd. Vs. ACIT vide order dt. 12/10/2017, (copy of which is placed at page no. 109 to 111 of the assessee’s paper book) therefore the Ld. CIT(A) was not justified in sustaining the addition made by the AO.

26. In his rival submission the Ld. CIT DR reiterated the observation made by the authorities below in their respective orders and strongly supported the impugned order passed by the Ld. CIT(A).

27. We have considered the submissions of both the parties and perused the material available on the record, it is noticed that an identical issue having similar facts was a subject matter of the assessee’s appeal in the case of M/s Monte Carlo Fashions Ltd. Vs. ACIT (supra) wherein vide order dt. 12/10/2017 the issue have been decided in favour of the assessee and the relevant findings have been given in para 10 and 11 which read as under:

10. We have heard Ld. Representatives of both the parties and perused the material available on record.

 1 1. It is also to be noted that the Finance Act 2003 has amended Section 36(1)(iii) by inserting a proviso to the existing provision w.e.f 01.04.2004 relevant to assessment year 2004-05. The proviso inserted to the existing provision of section 36(1)(iii) is reproduced as under:

“ Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalized in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.”

The judgment of various Courts in the case of Hero Cycles (P) Ltd. Vs. CIT, Ludhiana C.A. No. 514 of 2008 dt. 05/1 1/2015, Bright Enterprises Pvt. Ltd. Vs. CIT, Jalandhar (20 16) 381 ITR 107 (P&H) held that no disallowance of interest is called for where the assessee has got sufficient own funds. The Assessing Officer is directed to go through the fund position namely capital and interest free advances, reserves and surplus to determine whether any borrowed funds have been utilized more than available own funds and take a decision keeping in view the decisions rendered above. If sufficient own funds are available, no disallowance is called for. This ground may be treated as set aside to the file of Assessing Officer.

So respectfully following the aforesaid referred to order of this Bench of the Tribunal the issue under consideration is set aside to the file of the AO to be decided as per the directions given in the aforesaid referred to order dated 12/10/2017 in the case of M/s Monte Carlo Fashions Ltd. Vs. ACIT in ITA No. 1341/Chd/2016 for the A.Y. 2012-13. Accordingly this ground is allowed for statistical purposes.

28. The next issue vide Ground No. 4 relates to the sustenance of addition of Rs. 2,63,24,29/- made by the AO under proviso to section 36(1)(iii) on account of borrowed amount utilized from mixed funds lying in C.C. account, for purchase of fixed assets.

29. The facts related to this issue in brief are that the AO during the course of assessment proceedings noticed that the assessee had made an addition to the assets to the extent of Rs. 74,52,27,049/- and also had shown Capital Work in Progress to the extent of Rs. 41,41,88,201/-. The AO asked the assessee to furnish working of interest capitalized, on the loans pertaining to assets purchased and put to use or under installation as Capital Work in Progress. In response the assessee submitted that the payment for the purchase of assets had been made out of the share capital and reserves i.e; interest free funds and that whatever loans had been taken for purchase of assets had been received afterwards. Therefore the interest was not required to be disallowed in view of the provisions of section 36(1)(iii) of the Act, after the assets had been put to use. The AO again asked the assessee to explain as to why no interest was capitalized on assets purchased. In response the assessee submitted as under:

“Regarding the capitalization of interest on the machinery lying under the Capital work in progress, it is humbly reiterated as also discussed with your kind self during the assessment proceedings that the interest, if any paid on the money borrowed for the said purpose of purchase of machinery will be capitalized at the time of capitalization of machinery as per policy adopted as per accounting norms. The said interest for the purpose of capitalization in the case of fixed assets is normally computed from the date of purchase of machinery vis-a-vis the date of amount borrowed if any. This is evident from the detail filed by us. Even your kind self has asked us to compute the amount of interest from the date of payment upto the date of machinery installed irrespective of the fact that the machinery was lying in work in progress in earlier year. That the amount of interest was computed only for sake of cooperation and without prejudice to our legal objection that no interest from c.c. amount should be capitalized because the money borrowed from CC account was for business purpose only. The amount of interest can only be capitalized from the interest paid on long term borrowings only which has already been considered by the assessee.

29.1 The AO after considering the submission of the assessee observed that the assessee had submitted only working of interest on machineries which had been put to use during the Financial year relating to the Assessment Year under consideration and that the interest had been worked out from the date of payment to date of capitalization. He also observed that the assessee had submitted that although the interest was not required to be capitalized as the payments had been made out of the own sources but the working had been submitted as a matter of cooperation. The AO did not accept the aforesaid submissions of the assessee and observed that if the assessee was having its own funds then there was no need of raising borrowings and a part of funds were to be utilized from its own sources including unsecured loans for raising funds from banks. He also observed that investment in the gross block of assets was much more than the share capital and reserves as well as the term loans. The AO mentioned that the total term loans during the year were at Rs. 177.12 crores and the total share capital and reserves were at Rs. 275.97 crores i.e; Rs. 453.09 crores where as the gross block was Rs. 516.75. The AO made the disallowance of Rs. 2,63,24,29/- by observing at page no. 50 to 53 of the assessment order as under:

i.) The assessee’s argument that the payments for purchase of assets have been made out of own sources is not correct for the reasons discussed above. From the details furnished it is clear that there is gap between the payment made and actual user of the asset. As per proviso to section 36(l)(iii) of the I.T. Act interest is to be capitalized till the date of actual use for the purpose of business. It is also a fact that some of the assets have not been put to use for the purpose of business before the payment was made to the supplier. Hence, the interest for the period of actual payment to the date when the asset is actually put to use is required to be disallowed u/s 36(l)(iii) of the I.T. Act.

ii.) Though the assessee has claimed that the payments were made out of its own funds but the same is not tenable as the assessee has raised various loans during the year for running his business. The onus is on the assessee to establish that own funds were utilised. If the account is common for deposit of profits then automatically the debit balance will get reduced and consequently the interest would be lower. There is no substance in the argument of the assessee that only own funds were used. The payments for the purchase of assets were done through the same bank accounts where the profits of the business and the loan money received are being credited. Hence a clear cut distinction as to whether the loan funds or the profits of business were used for purchase of assets cannot be made. Accordingly, contention of the assessee company that it has not incurred any interest is not acceptable in view of the clear provision of explanation 8 of section 43(1) of the I.T. Act. As per the provision of Explanation to Section 43(1) which was inserted by the Finance Act, 1986, with retrospective effect from April 1,” 1974 where any amount is paid or is payable as interest in connection with acquisition of an asset, so much of such amount as is relatable to any period after such assets is first put to use is not to be included and is deemed never to have been included in the actual cost of such asset. The explanation intends to clarify the position of law as regards the capitalization of the interest paid in connection with acquisition of an asset after it has been put to use. Had it been the intention of the legislature to exclude interest from the actual cost, prior to the period the assets was first put to use the language of the explanation would certainly have been different. The explanation lays stress on the non inclusion of interest after the assets has been put to use. No doubt that this explanation was inserted with the viewpoint to reduce the misuse of investment allowance being made by various assesses, but it also clarifies the position in regard to the assessee. The intention of the legislature has further been explained vide circular No.461 dated 09.07.1986. Para 2 of this circular are reproduced here under: –

“It -is an accepted accounting principle that where an asset is acquired out of borrowed funds, the interest paid or payable on such funds constitutes the cost of borrowing and not the cost of the assets acquired with those funds. It is for this reason that as per the clear guidelines issued by the institute of chartered accountant of India, the interest on moneys which are specifically borrowed for the purchase of the fixed assets may be capitalized only relating to the period prior to the assets coming in to production i.e. relating to the erection stage of the assets. However, once the production starts no interest on borrowing for the purchase of the assets should be capitalized.”

6.3 It is also to be noted that the Finance Act 2003 has amended Section (1) (iii) by inserting a proviso to the existing provision w.e.f. 01.04.20 04 relevant to assessment year 2004-2005. The proviso inserted to existing provision of section 36(1) (iii) is reproduced as under:

“Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business « profession (whether capitalized in the books of account or not); for any period beginning from the date on which the capital was borrowed faracquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction”

6.4 The assessee’s argument that the payments for purchase of assets out of own funds is, therefore, not acceptable. As per proviso to section 36(l)(ii) of the I.T. Act interest is to be capitalized till the date of actual use for the purpose of business. The assessee has furnished the working of interest from date of payment to date of actual use as below:

It is believed that the assessee has made correct calculations. Later on, if it is found that there is error in calculation the same would be rectified. The interest to the extent of Rs. 26,32,429/- is therefore capitalized under provision to section 36(1)(iii) of the I.T. Act. The same would form part of the assets and depreciation would be allowed accordingly if the assesse does not contest this addition before the appellate authority. Disallowance on this account comes to Rs. 26,32,429/-.

30. Being aggrieved the assessee carried the matter to the Ld. CIT(A) and submitted that the term loan raised for the purpose of purchase of fixed assets was mostly disbursed after the machinery was purchased and installed. The interest on term loan raised had been properly capitalized wherever applicable and that the amount for purchase of machinery was paid out of own funds i.e; capital reserves and surplus available with the assessee company lying in the CC account, therefore the addition made by the AO was not justified. The submission of the assessee was forwarded by the Ld. CIT(A) to the AO who vide his report dt. 18/09/2014 referred to the observations made in the assessment order and pointed out that the assessee had not furnished clear cut evidence of purchase of fixed assets out of non borrowed funds with respect to which no interest had been capitalized and that since the assessee had mixed funds therefore onus was on the assessee to show that the plant and machinery was purchased from own sources and own borrowed funds were not utilized for this purpose.

30.1 The Ld. CIT(A) after considering the submissions of the assessee and remand report of the AO observed that the assessee had made addition to the fixed assets to the extent of Rs. 135.4996 crores during the year and had shown capital work in progress to the extent of Rs. 39.9533 crores and had taken term loan during the year to the extent of Rs. 546.79 crores. According to the Ld. CIT(A)the borrowed funds were used for investment in assets and towards capital work in progress which required to be capitalized in accordance with the provisions of the proviso to section 36(i)(iii)of the Act. The Ld. CIT(A) did not agree with this contention of the assessee that no borrowed funds were used and the fixed assets were purchased out of own funds and internal accruals. The Ld. CIT(A) observed that the AO had pointed out in the assessment order that the assessee had made payments for purchase of assets from the CC account with the bank on which interest was payable, therefore, the borrowed funds had been used for investment in fixed assets as well as for investment in work in progress and corresponding interest paid was required to be capitalized. The Ld. CIT(A) also observed that it was a case of mixed use of funds where borrowed funds have been used both for the purpose of investment in work in progress and in fixed assets as well as in shares and other business activities, it was in this background that the interest on term loan as well as other business loan were taken for the purpose of computation of disallowance under Rule 8D(2) r.w.s 14A of the Act. The Ld. CIT(A) deem it fair and reasonable to limit disallowance on account of capitalization of interest, fixed assets and capital work in progress to the extent of debt equity ratio. He accordingly asked the AO to recompute the disallowance by adopting the debt equity ratio and restrict the disallowance accordingly and that any excess depreciation allowed on account of capitalization of interest may be withdrawn.

31. Now the assessee is in appeal.

32. The Ld. Counsel for the assessee at the very outset stated that this issue is squarely covered in favour of the assessee in the case of Group Company i.e; M/s Monte Carlo Fashions Ltd. Vs. Asst. CIT in ITA No. 1341/Chd/2016 vide order dt. 12/10/2017, copy of the same was furnished.

33. In his rivals submissions the Ld. CIT DR strongly supported the impugned order passed by the Ld. CIT(A) and reiterated the observations made therein.

34. We have considered the submissions of both the parties and perused the material available on the record, it is noticed that an identical issue having similar facts has already been decided by the ITAT Chandigarh Bench in ITA No. 1341/Chd/2016 for the A.Y 2012-13 in case of M/s Monte Carlo Fashions Ltd. Vs. Asst. CIT, a group company of the assessee wherein the relevant findings have been given vide order dt. 12/10/2017 in para 10 & 11 which read as under:

10. We have heard Ld. Representatives of both the parties and perused the material available on record.

 11. It is also to be noted that the Finance Act 2003 has amended Section 36(1)(iii) by inserting a proviso to the existing provision w.e.f 01.04.2004 relevant to assessment year 2004-05. The proviso inserted to the existing provision of section 36(1)(iii) is reproduced as under:

“ Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an asset for extension of existing business or profession (whether capitalized in the books of account or not); for any period beginning from the date on which the capital was borrowed for acquisition of the asset till the date on which such asset was first put to use, shall not be allowed as deduction.”

The judgment of various Courts in the case of Hero Cycles (P) Ltd. Vs. CIT, Ludhiana C.A. No. 514 of 2008 dt. 05/1 1/2015, Bright Enterprises Pvt. Ltd. Vs. CIT, Jalandhar (20 16) 381 ITR 107 (P&H) held that no disallowance of interest is called for where the assessee has got sufficient own funds. The Assessing Officer is directed to go through the fund position namely capital and interest free advances, reserves and surplus to determine whether any borrowed funds have been utilized more than available own funds and take a decision keeping in view the decisions rendered above. If sufficient own funds are available, no disallowance is called for. This ground may be treated as set aside to the file of Assessing Officer.

So respectfully following the aforesaid referred to order, this issue is set aside to the file of the AO to be decided as per the directions given vide aforesaid referred to order dt. 12/10/2017. Accordingly this issue is decided in favour of the assessee for statistical purposes.

35. In ITA No. 184/Chd/2015 and ITA No. 149/Chd/2015 in the case of M/s Nahar Industrial Enterprises Ltd Vs. Additional CIT and M/s Nahar Spinning Mills Ltd. Vs. ACIT respectively, identical issues have been raised having similar facts the only difference is in the amount involved, therefore, our findings given in the former part of this order in ITA No. 153/Chd/2015 in the case of Oswal Woolen Mills Ltd. Vs. Addl. CIT, shall apply mutatis mutandis to the aforesaid appeals of the assessees.

36. Now we will deal with the appeal of the Department in ITA No. 200/Chd/2015.

37. Following grounds have been raised in this appeal :

1. Whether in the facts and circumstances of the case, Ld. CIT(A) has erred in law in directing the AO to allow the claim of the assessee on the issue of additional depreciation and carbon credits entitlements during assessment proceedings ignoring that there are no provision under the Income Tax Act to make amendment in the return of income at the assessment stage without revising the return.

2. Whether in the facts and circumstances of the case, Ld. CIT(A) has erred in law in directing the AO to allow the claim of the assessee on the issue of additional depreciation and carbon credits entitlements during assessment proceedings ignoring the decision of Hon ble Supreme Court in the case of Goetz (India) Ltd. Vs CIT 284 ITR 323 wherein it was held by the Apex Court that assessee could not make a claim for deduction other than filing a revised return.

3. Whether on the facts and circumstances of the case Ld. CIT(A) has erred in law in allowing the deduction in returned income of Rs.2,36,55,831/- on a/c of additional depreciation ignoring that there is no provision in the income tax act regarding carry forward of the additional depreciation.

4. Whether on the facts and in the circumstances of case the Ld. CIT(A) has erred in law in allowing the deduction in returned income of Rs. 1,21,52,807/- accrued on account of carbon credits entitlement ignoring that such profits are included in the definition of income as per section 2(24)(xii) of the I.T. Act, 1961 and also not noticing the decision of Hon ble ITAT, Chennai in the case of M/ s Sripathi Paper & Boards Pvt. Ltd. Vs. DCIT, Circle 1(2), Coimbatore in ITA No. 1452/Mds/2012 dated 29.11.2012 for the A.Y. 2009-10 (copy enclosed).

5. That the appellant craves leave to add or amend any ground of appeal before it is finally disposed off.

38. First issue agitated by the Department vide Ground No. 3 read with Ground No. 1 & 2 relates to the allowing the deduction of additional depreciation amounting to Rs. 2,36,55,831/-.

39. The facts related to this issue in brief are that the assessee vide letter dt. 14/02/2014 claimed additional depreciation on the machinery installed and put to use. The AO did not discuss this claim of the assessee in the assessment order. The assessee submitted to the Ld. CIT(A) as under:

“ It is submitted that it is an accepted and admitted fact that appellant acquired and installed new machinery in the preceding year, when the Ld. Assessing Officer allowed the normal depreciation as well as additional depreciation in the said year. But on the machinery which was installed and used for less than 180 days, the additional depreciation was restricted to fifty percent. The provisions of Section 32(1)(ii) envisage that assessee is eligible for initial/additional depreciation @ 20% of the cost of machinery. The proviso to Section 32(l)(ii) only restrict that if machinery was acquired during the previous year and put to use for less than 180 days, the deduction shall be restricted to 50% of the amount calculated in the said year. The balance 50% of the restricted allowance is to be given in subsequent year as the appellant was eligible to claim additional depreciation @ 20% but restricted to 50% thereof because of working of assets for less than 180 days in the said year. Since the machinery is still in use therefore the eligibility for claiming balance additional depreciation cannot be denied by invoking proviso to section 32(l)(iia) of the Act.

The contention of the appellant is substantiated by various benches of the ITAT. The humble appellant relies upon the following decisions:

1) Apollo Tyres Ltd. Vs. ACIT (Cochin Bench).

2) MITC Roling Mills Pvt. Ltd. Vs. ACIT (Bombay Bench).

3) DIVIS Laboratory Ltd. Vs. DCIT (Hyderabad Bench)… IT A No. ll/HYD/2012.

4) DCIT Vs. SIL Investment Ltd…. 148 TTJ 213(Delhi).

5) Addl. CITVs. Cosmo Films Ltd 13ITR (Trib) 340-ITAT (Delhi).

39.1 The copy of the submission made by the assessee was forwarded to the AO who reported as under:

“In this ground the assessee has taken a plea that the AO has erred in law ^and on facts in not allowing the addition depreciation of Rs. 2,14,83,532/-being balance 10% on the cost of machinery which was put to use for less than 180 days during the preceding year and restricted during the said year. This plea of the assessee is completely incorrect. It is to be noted that the second proviso to clause (ii) of section 32(1) read with clause (iia) of section 32(1) of the I T . Act, 1961 expressly provide for additional depreciation at half the rate for assets which are put to use for less than 180 days. Further, there is no provision in the statute regarding carry forward of the additional depreciation.

In this case the assessee has never claimed this carry forward of additional depreciation in its return of income. Moreover, this issue does not emanate from any earlier year order. In such situation, there are no provisions under the I. T. Act to make amendment in the return of income at the assesseement stage without revising the return. This argument of revenue is well supported by the decision of Hon ‘ble Supreme Court in the case of Goetze (India) Ltd. vs. CIT, 284 ITR 323 in which the Hon ‘ble Court has dismissed the appellant of the assessee on the issue whether the appellant assessee could make a claim for deduction other than by filing a revised return. Also the assessee has relied upon the case law DCIT vs. SIL Ltd. 148 TTJ 213 (Delhi). It is pertinent to mention that the facts in this case are totally different to the case of the assessee. In this decision since 50% of the depreciation was already allowed by the AO in the immediately proceedings assessment year, hence, the balance 50% of the additional depreciation was allowed after factual verification, no such facts exist in the case of the assessee. Moreover, the other case laws given by the assessee lack any citation details, hence cannot be discussed. Thus, in view of the discussion above, the contention of the assessee is incorrect. Kindly decide this ground of appeal on the basis of these facts & rejecting the submission of the assessee. “

39.2 The Ld. CIT(A) after considering the submission of the assessee and the report of the AO allowed the claim of the assessee by observing in para 8.5 to 8.8 of the impugned order which read as under:

8.5 I have carefully considered the appellant’s submissions. The appellant had made this claim of additional depreciation through letter dated 14.02.2014. The AO has disallowed this claim on the ground that the claim was not made in the return of income. Therefore, the claim made by letter filed during the course of assessment proceedings was held to be not allowable. The only issue to be considered is whether such claim made during the course of assessment proceedings through a letter and not through revised return was a valid claim. Reference in this regard may be made to the case of Budhewal Co-operative Society Ltd. In this case claim of deduction u/s 80P was disallowed by the AO on the ground that the claim was not made in the original return of income nor any revised return was filed for this claim. The claim had been made during the assessment proceedings through the letter filed before the AO. The disallowance made by the AO was confirmed by me vide order dated 24.08.2012 in Appeal No. 44/ROT/IT/CIT(A)-II/Ldh relying on the case of Goetze India Ltd. Hon’ble ITAT Chandigarh Bench, vide its decision dated 24.5.2013, in the case of Budhewal Co-operative Society Ltd., in ITA No. 1077/Chd/2012, reversed my order and held that an assessee can raise additional grounds and make claims during the assessment proceedings and even during the appellate proceedings. The Hon’ble ITAT held as under:-

“We find that the Hon ‘ble Punjab & Haryana High Court in CIT vs. Ramco International (supra) allowed the claim of deduction under section 80IB of the Act as the form No. 10CCB in respect of the said claim was filed during the assessment proceedings and it was held that the assessee was not to make any fresh claim and had duly furnished and submitted the form for deduction, there was no requirement of filing any revised return. The plea of the Revenue before the Hon ‘ble High Court that the judgment of Hon ‘ble Supreme Court in Goetze (India) Ltd., vs. CIT (supra) was applicable and deduction was not allowable, was not accepted by the Hon ‘ble Court.

In view of the above said ratio laid down by the Hon ‘ble Punjab & Haryana High Court in CIT vs. Ramco International (supra), we are of the view that the claim of deduction made by the assessee u/s 80P(2)(a)(iii) of the Act is to be considered in the present facts and circumstances of the case, even though the assessee had raised said claim by way of letter dated 15.12.2004 and had not furnished any revised return of income. “

8.6 Respectfully following the decisions of the Hon’ble ITAT in the case of Budhewal Co­operative Society Ltd (Supra), I hold that the claim of additional depreciation made by the appellant during the course of assessment proceedings vide letter dated 14.02.2014 was a valid claim. That being so the AO was not justified in rejecting the claim of the appellant pertaining to additional depreciation merely on the ground that the claim was made through a letter and not through revised return.

8.7 Now coming to the merits of the claim. The issue is squarely covered by the various decision relied upon by the appellant as reproduced in para 8.2 above. The AO has not referred to any contrary decision on this issue.

8.8 The AO is directed to examine the appellant’s claim for additional depreciation is requested for by the appellant, vide letter dated 14.02.2014 and allow the same in accordance with the law. This ground of appeal is accordingly allowed.

40. Now the Department is in appeal.

41. The Ld. CIT DR submitted that the assessee did not claim the additional depreciation in the original return of income, therefore, the AO was justified in not allowing the claim of the assessee raised during the assessment proceedings.

42. In his rival submissions the Ld. Counsel for the assessee reiterated the submissions made before the Ld. CIT(A) and further submitted that the Ld. CIT(A) followed the decision of the ITAT and allowed the claim of the assessee therefore, no interference is called for in the just order passed by the Ld. CIT(A). It was further stated that the AO himself allowed the claim of the assessee in subsequent assessment years i.e; A.Y. 2014­15 to 2017-18 copies of which are placed at page no. 47 to 102 of the assessee’s paper book.

43. We have considered the submissions of both the parties and perused the material available on the record. It is noticed that the Ld. CIT(A) rightly allowed the claim of the assessee by following the decision dt. 24/05/2013 of the ITAT Chandigarh Bench in the case of Budhewal Co-operative Society Ltd. in ITA No. 1077/Chd/2012 wherein it was held as under:

“We find that the Hon ‘ble Punjab & Haryana High Court in CIT vs. Ramco International (supra) allowed the claim of deduction under section 80IB of the Act as the form No. 10CCB in respect of the said claim was filed during the assessment proceedings and it was held that the assessee was not to make any fresh claim and had duly furnished and submitted the form for deduction, there was no requirement of filing any revised return. The plea of the Revenue before the Hon ‘ble High Court that the judgment of Hon ‘ble Supreme Court in Goetze (India) Ltd., vs. CIT (supra) was applicable and deduction was not allowable, was not accepted by the Hon ‘ble Court.

In view of the above said ratio laid down by the Hon ‘ble Punjab & Haryana High Court in CIT vs. Ramco International (supra), we are of the view that the claim of deduction made by the assessee u/s 80P(2)(a)(iii) of the Act is to be considered in the present facts and circumstances of the case, even though the assessee had raised said claim by way of letter dated 15.12.2004 and had not furnished any revised return of income. “

We therefore by respectfully following the aforesaid order dated 24/05/2013 in the case of M/s Budhewal Co-operative Society Ltd. do not see any valid ground to interfere with the findings given by the Ld. CIT(A).

44. The next issue vide Ground No. 4 read with Ground No. 1 & 2 relates to the deduction of Rs. 1,21,52,807/- accrued on account of carbon credits.

45. The facts related to this issue in brief are that the assessee had shown income of Rs. 1,74,28,246 under the head “carbon credit received” which was based upon the total carbon emission reduction made by the company during the calendar year. It was based upon the power generation by the assessee company. Since there was difference in power generation (MWH) as shown in balance sheet and the computation submitted, the assessee was asked to give the reason for such difference. In response the assessee submitted that there was difference in total generation of power and net power generated because some part of power was used in house for the generation of power. The Assesse also claimed that the amount of carbon credit should be considered as capital receipt. The reliance was placed on the decision of the ITAT Hyderabad Bench in the case of My Home Power Ltd. Vs. DCIT reported at 151 TTJ(Hyd) 616. The AO after considering the submissions of the assessee treated the amount in question as revenue receipt instead of capital receipt by observing in para 7.2 of the assessment order as under:

7.2 It is also pertinent to note that CER does not come under the second proviso of Sec. 28(va) which exclude any sum received under agreement from profit under business & profession and thus it is included in the definition of income as per Section 2 (24) (xii) of Income Tax Act. In the decision of Tarak Chemicals Pvt. Ltd., Mumbai dated 08.02.2013 the ITAT Mumbai held the compensation from multilateral fund under the Montreal fund for phasing out the production of environmental unfriendly substance only when the complete facts were produced before CIT (A) and was found to be covered under second proviso of Section 28 (va) of Lncome Tax Act. Notwithstanding discussion above the department has not accepted the view of ITAT and has preferred appeal before the Hon’ble High Court. More over the assessee itself has offered it taxation. No claim can be made without filing a revised return. The assessee has not furnished any revised return. Hence the claim of the assessee is rejected and the same is treated as revenue receipt.

46. Being aggrieved the assessee carried the matter to the Ld. CIT(A) and submitted as under:

“ That the appellant had shown receipt of Rs. 2,55,55,850/- under the head Carbon Credit Receipts Curing the course of assessment proceedings the humble appellant claimed vide our letter dated 14.02.2014 enclosed as Annexure-VII that the amount of Carbon Credit receipts were capital receipts and not a revenue receipt. The said claim was made on the basis that C.E.R undoubtedly known as Carbon Credits commodity and are quoted in stock exchanges like MCX and NCDE. The gain from the carbon credits represents the receipt to compensate the unforeseen able loss. The view of the humble appellant was also fully subscribed by hon ble ITAT(Hyderabad) in the case of My Home Power Ltd, reported in 151TTJ616.

The Ld. Assessing Officer rejected the claim of the appellant and assessed the said receipts as revenue receipts on the basis that the department has not accepted the view of the IT AT and has preferred appeal before Hon ble High Court.

We may further inform you that the identical issue has already been decided by your kind self in the case of Nahar Industrial Enterprises Ltd. in appeal No. 78/IT/2013-14 (copy enclosed as Annexure-VIII). In the said order it was held that the Carbon Credit receipts is not a revenue receipts but capital receipts. It is humbly prayed that since the issue is covered by the order of this Hon ble appellate authority, therefore by following the said order the assessing officer may kindly be directed to consider Carbon Credits as capital receipts. “

46.1 The submission of the assessee were forwarded to the AO who narrated the facts mentioned in the assessment order in his report dt. 18/09/2014. The Ld. CIT(A) by following his earlier order for the A.Y. 2010-11 allowed the claim of the assessee. The relevant findings have been given in para 9.6 of the impugned order which read as under;

9.6. I have carefully considered the appellant s submissions. I have carefully considered the appellant s submissions. Similar issue was decided by me in the appellant s own case for assessment year 2010-11. In this order dated 19.02.2014 in appeal No. 78/IT/CIT(A)-II/Ldh/2013-14 it was held as under:-

“I have carefully considered the appellant s submission. The only issue to be considered is whether the receipts on account of carbon credits are revenue receipts or capital receipts. The appellant has relied on the decision of the Hon ble IT AT (Hyd) in the case of My Home Power Ltd., (Supra) wherein the Hon ble IT AT has held that the receipts on account of carbon credits are capital receipts. Similar view has been held by the Hon ble ITAT Jaipur in the case of Shree Cements Ltd., vs. Addl. CIT in IT A No. 503/JP/2012. In this decision dated 27.01.2014, the Hon ble ITAT held as under :-

“38. We have heard the rival submissions and perused the evidence on record. We find that the Appellate Tribunal in My Home Power Ltd Vs. DCIT [supra], have, after detailed examination, concluded that the receipts from Carbon credit are capital in nature. We are inclined tofollow the said decision and the other two decisions of Chennai Tribunal in Sri Velayudhaswamy Spinning Mills (P.) Ltd. Vs. DCIT [supra] and Ambika Cotton Mills Ltd. Vs. DCIT (supra) where also it has been held that receipt on account of Carbon Credit is capital in nature & neither chargeable to tax under the head Business Income nor liable to tax under the head Capital Gains. Our above view is also supported by the decision of Supreme Court in the case of Vodafone International Holdings Vs. UOI [supra] wherein Supreme Court has held that treatment of any particular item in different manner in the 1961 Act and DTC serves as an important guide in determining the taxability of said item. Since DTC by virtue of the deeming provisions specifically provides for taxability of 37 carbon credit as business receipt and Income Tax Act does not do so, our view gets duly fortified by the principles stated in the above decision of Supreme Court. Accordingly this ground of the assessee is allowed and the addition made by the AO is deleted.”

47. Now the Department is in appeal.

48. The Ld. CIT DR supported the order passed by the AO and reiterated the observations made therein.

49. In his rival submissions the Ld. Counsel for the assessee reiterated the submissions made before the authorities below and further submitted that an identical issue having similar facts had been decided in favour of the assessee vide order dt. 16/12/2015 in ITA No. 1122/Chd/2014 for the A.Y. 2010-11 in assessee’s own case, copy of the said order was furnished which is placed on record.

50. After considering the submissions of both the parties and material available on the record it is noticed that an identical issue having similar facts was a subject matter of the Departmental appeal in assessee’s own case in the preceding assessment year 2010-11 wherein the appeal of the department was dismissed by observing in para 2 to 4 of the order dt. 16/12/2015 which read as under:

2. The brief facts are that Assessing Officer noted that assessee had shown income of Rs.1.21 Cr under the head Carbon Credit Receipts. This income was based upon total carbon emission reduction made by company during the year. The assessee had claimed these receipts to be capital receipts. The Assessing Officer held that these receipts were revenue receipts and added to the income of the assessee. The assessee filed written submissions before ld. CIT(Appeals) which is quoted in the appellate order in which the assessee explained that the said claim was made on the basis that CER undoubtedly known as Carbon Credit Commodity and are quoted in stock exchange like MCX and NCDE. The gain from the carbon credits represents the receipt to compensate the unforeseenable loss. The view of the assessee was also fully subscribed by ITAT Hyderabad Bench in the case of My Home Power Ltd. reported in 151 TTJ 616. The Assessing Officer rejected the claim of the assessee because the view of the Tribunal is not accepted by the Revenue Department and appeal is pending before High Court. It was also submitted that on identical issue, ld. CIT(A) has decided the issue in favour of the assessee in the case of Nahar Industrial Enterprises Ltd. Copy of the order is placed on record in which it was held that carbon credit receipt is not revenue receipt but capital receipt. The ld. CIT(Appeals), following his order in assessee’s group cases of M/s Nahar Industrial Enterprises Ltd. dated 19.02.2014 allowed the appeal of the assessee.

3. The ld. counsel for the assessee, at the outset submitted that the issue is covered in favour of the assessee by order of ITAT Chandigarh Bench dated 15.04.2015 in ITA No. 389/CHD/2013 for assessment year 2009-10 in the case of DCIT Vs Kotla Hydro Power Pvt. Ltd., copy of the same is placed on record in which in para 7 to 9, the Tribunal held as under :

“7. We have considered the rival submissions carefully. The facts of the case are identical to the facts of the case decided by Hyderabad Bench of the Tribunal in the case of My Home Power Ltd Vs. DCIT (supra). In that case it was held as under:-

“Held, that carbon credit was in the nature of “an entitlement” received to improve world atmosphere and environment reducing carbon, heat and gas emissions. It was not an offshoot of business but an offshoot of environmental concerns. No asset was generated in the course of business. Credit for reducing carbon emission or greenhouse effect could be transferred to another party in need of reduction of carbon emission. It does not increase profits in any manner and does not need any expenses. It was in the nature of entitlement to reduce carbon emission, and there was no cost of acquisition or cost of production to get this entitlement. Carbon credit was not in the nature of profit or in the nature of income. The amount realized on transfer of carbon credit was not taxable. “

8. This decision was confirmed by Hon ble Andhra Pradesh High Court in the decision of CIT Vs. My Home Power Ltd Vs. DCIT 365 ITR 82(A.P.) and it was held as under:-

“Held, dismissing the appeal, that the assessee was carrying on the business of power generation for the assessment year 2007-08. Carbon credit was not an offshoot of business of the assessee but an offshoot of environmental concerns. No asset was generated in the course of business but it was generated due to environmental concerns. There was no cost of acquisition or cost of production to get entitlement for the carbon credits. Therefore, the income from sale of carbon credits was to be considered as capital receipt and not liable to tax under any head of income under the Income-tax Act, 1961.”

9. Further, this decision has been followed by Chennai Bench in two cases of Ambika Cotton Mills Ltd v DCIT (supra) and Sri Velayudhaswamy Spinning Mills P. Ltd v DCIT (supra). Even Jaipur Beach has followed this decision in the case of Shree Cement Ltd Vs. Addl CIT (supra). No doubt the DR has been able to point out the contrary decision rendered by Cochin Bench of the Tribunal in the case of Apollo Tyres Ltd v ACIT (supra). Since the decision of Hyderabad Tribunal Bench has already been confirmed by the Hon ble Andhra Pradesh High Court and there is no contrary decision from any other High Court, in our opinion, we are bound to follow the decision of High Court. Therefore, following this decision we decide this issue against the Revenue.”

4. Considering the above, we find that the issue is covered in favour of the assessee by order of ITAT Chandigarh Bench in the case of Kotla Hydro Power Pvt. Ltd. (supra). The departmental appeal, therefore, stands dismissed.

So respectfully following the aforesaid referred to order dt. 16/12/2015 in ITA No. 1122/Chd/2014 for the A.Y. 2010-11 in assessee’s own case, we do not see any merit in this ground of the departmental appeal.

51. In ITA No. 201 & 202/Chd/2015 preferred by the Department, similar issues are raised as were involved in ITA No. 200/Chd/2015 for the A.Y. 2011-12 therefore our findings given in former part of this order for the A.Y. 2011-12 shall apply mutatis mutandis for these appeals also.

52. In the result appeals of the assessee’s are partly allowed for statistical purposes and appeal of the Department are dismissed.

(Order pronounced in the open Court on 22/07/2022)