M/S UDUPI POWER CORPORATION LIMITED ,BANGALORE vs. THE DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-7(1)(1), BANGALORE

The assessee is engaged in the business of generation of sale of power.

The first common issue urged in both the years relates to disallowance of claim of “marked to market losses” on restatement of outstanding forward contracts. The AO noticed that the assessee has valued outstanding foreign exchange forward contracts as at the year end and the same has resulted in a loss of 141.63 lakhs and 1097.00 lakhs respectively in asst. year 2011-12 and 2012-13. By taking support of CBDT Instruction No.3 of 2010 dated 23/3/2010, the AO held that the same is notional loss and also speculative in nature. Accordingly he disallowed the above said claim in both the years. The ld CIT(A) also confirmed the same.

The ld AR submitted that claim of the assessee is supported by the decision rendered by coordinate bench in the case of Quality Engineering and Software Technologies Pvt. Ltd., Vs. DCIT (2014) 52 Taxmann.com 515, wherein the Tribunal has held that the forward contract entered in order to protect the interest of the assessee against fluctuations in foreign currency in respect of consideration receivable for exports made would not qualified to be called as speculative transaction and hence the provision for losses incurred on derivative contracts is an allowable expenditure.

On the contrary, the ld DR supported the order passed by the ld CIT(A). He relied on the Instruction issued by CBDT and submitted that the said loss is notional one. The ld DR also submitted that the assessee, in any case, has not shown the nexus between outstanding forward contracts and import/export activities of the assessee.

We heard the parties on this issue and perused the record. We noticed that coordinate bench has held in the case of Quality Engineering and Software Technologies Pvt. Ltd., that the provision made for losses incurred on derivative contracts is an allowable expenditure, since they are entered into in order to protect the interests of assessee against loss arising on account of foreign exchange fluctuations while realizing the export proceeds. We noticed that the said decision was rendered after considering the CBDT Instruction No.3/12, on which the AO had placed reliance. Hence, the claim of the assessee is, in principle, allowable. However, as rightly pointed out by ld DR, the assessee should establish the nexus between the outstanding forward contracts and import/export activities of the assessee. Hence, for the limited purpose of verification of nexus referred above, we restore this issue to the file of the AO in both the years under consideration to examine the issue afresh by following the decision rendered in the case of Quality Engineering and Software Technologies Pvt. Ltd. (supra). Needless to mention the assessee should be given proper opportunity of being heard. The order passed by the ld CIT(A) is set aside accordingly.

The next common issue relates to disallowance made u/s 14A of the Act. The assessee received dividend income of Rs.268.66 lakhs and 630.84 lakhs during the previous years relevant to the asst. years 2011-12 and 2012-13 respectively. The assessee did not make any disallowance u/s 14A of the Act. Before the AO the assessee contended that it did not incur any specific expenditure in earning the dividend income and accordingly contended that no disallowance u/s 14A is called for. The AO did not agree with the contentions of the assessee and he took the view that a portion of administrative expenses should be disallowed by applying Rule 8D(2)(iii) of the Income-tax Rule. Accordingly the AO disallowed 0.5% of the average value of investment in both the years which worked out 46.43 lakhs and 11.75 lakhs respectively in asst. year 2011-12 and 2012-13. The ld CIT(A) confirmed the same.

The ld AR submitted that the assessee has made investments of its surplus funds in the schemes of various mutual funds which do not require critical analysis. The AR accordingly submitted that the provision of Rule 8D(2)(iii) should not be applied in the facts and circumstances of the case. The ld AR also took up support of decision rendered by Mumbai Bench of ITAT Svitzer Hazira Pvt. Ltd., (2017) 85 taxmann.com 91 (Mumb – Trib.), wherein the Tribunal, on identical set of facts, has made adhoc disallowance by observing that the provision of Rule 8D(2)(iii) need not be applied.

We heard the ld DR and perused the record. We noticed that the assesee held investments in mutual funds only. The assessee has held investment in 7 schemes and in 3 schemes as on 1/4/2010 and 31/3/2011 respectively. It is an admitted fact that the investment in mutual fund scheme does not involve critical analysis as may be required while making investments in shares. Hence, there is merit in the contention of the assessee that the provision of Rule 8D(2)(iii) need not be applied in the facts and circumstances of the case. At the same time, the activities connected thereto, viz., making investments in the mutual funds schemes, redemption thereof, receipt of dividend etc. would consume some of the administrative expenses. Hence, disallowance us/ 14A of the Act is called for and it may be estimated on adhoc basis, in the facts and circumstances of the case. Considering the dividend income received and the activities undertaken in making investments in Mutual Fund schemes and redemption thereof, we are of the view that the disallowance of Rs.25,000/- and Rs.50,000/- may be made respectively in asst. year 2011-12 and 2012-13 and in our view the same would meet the requirements of sec. 14A of the Act. Accordingly we set aside the order passed by ld CIT(A) on this issue in both the years and direct the AO to restrict the disallowance to the extent sated above in the years under consideration.

Now we shall take up individual issues agitated in both the years.

In asst. year 2011-12, the assessee is agitating the disallowance of depreciation claimed on pre operative expenses. The AO noticed that the assessee has capitalized pre operative expenses and claimed depreciation thereon. The AO asked the assessee to explain as to why deprecation claimed on these expenses should not be disallowed. Since the assessee did not furnish any reply, the AO disallowed the depreciation of Rs.25.91 lakhs claimed on pre operative expenses. The ld CIT(A) also confirmed the same, since the assessee did not furnish any reply before him also.

The ld AR submitted that the assessee, for some unavoidable reasons, could not furnish proper reply to the tax authorities and accordingly prayed that the assessee may be provided with one more opportunity to furnish relevant details before the AO.

We heard the ld DR and perused the record. In the interest of natural justice, we are of the view that the assessee may be provided with one more opportunity to furnish the details that were called for by the AO. Accordingly we set aside the order passed by the ld CIT(A) and restore this issue to the file of the AO for examining it afresh.

In AY 2012-13, the assessee is agitating the decision of ld CIT(A) in confirming the assessment of interest received from inter corporate deposits as income chargeable to tax under the head income from other sources and also in rejecting the claim of the assessee for netting of interest income against interest paid on borrowed funds.

We heard the parties on this issue and perused the record. The AO noticed that the assessee has advanced a sum of Rs.200 cores as inter-corporate deposits to M/s Lanco Infratech Ltd. The assessee claimed that it had taken loan of 200 crores from Bank of India and advanced the same to M/s Lanco Infratech Ltd. The assessee received interest income of Rs.31.08 crores from the inter- corporate deposit and claimed equal amount as interest expenditure on loan taken from Bank of India and accordingly declared NIL income from the above transactions. The AO noticed that the assessee has capitalized other interest payable on bank loans, since the power plants were still under erection and yet to be commissioned. He further noticed that the loan of Rs.200 crores has been taken by the assessee as “Mezzanine debt” in connection with the construction of power project. Accordingly he took the view that the interest payable on the loan of Rs.200 crores taken from the bank should also be capitalized. He further took the view that the income earned by the assessee from inter-corporate deposit is assessable as ‘income from other sources’ as per the decision rendered by the Hon’ble Supreme Court in the case of Tuticorin Alcoholic Chemicals and Fertilizers Ltd., Vs. CIT 227 ITR 172. Accordingly he assessed the interest income of Rs.31. 08 crores as income of the assessee under the head ‘income from other sources’ and did not allow deduction of interest expenditure. The ld CIT(A) also rejected the claim of the assessee for set off of interest income against the interest expenditure and accordingly confirmed the action of the AO in assessing the interest income as income under the head ‘income from other sources’.

From the facts discussed above, we notice that the assessee has borrowed Rs.200 crores from Bank of India and lent the same as inter-corporate deposits to M/s Lanco Infratech Ltd. The AO/CIT(A) noticed that the assessee has taken the above said loan as “Mezzanine Debit” for the purpose of execution of power project and hence the interest expenditure should have been capitalized by the assessee. Accordingly the AO disallowed the interest expenditure claim.

However, the submission of the assessee is that the above said loan of Rs.200 crores have been lent as inter corporate deposit and hence there is direct nexus between the loan taken from bank and the inter-corporate deposit made. If the assessee is able to establish direct nexus, then the interest payable on bank loan can be claimed as deduction against interest income earned from inter- corporate deposit. The question of capitalization of interest shall arise only if the concerned loan is used for the purpose of construction of power project. Here, it is the submission of the assessee that it has used the bank loan of Rs.200 crores for giving inter-corporate deposit. User of the loan shall determine the treatment of interest expenditure under the Act.

We notice that the assessee has claimed equal amount of interest income as interest expenditure. It claimed to have received interest income @ 15% on inter-corporate deposit. However, the details of interest expenditure payable on the bank loans were not available on record. Hence this aspect also requires verification.

Accordingly, we are of the view that this issue requires fresh examination at the end of the AO for the purpose of examining nexus between borrowed funds and the details of interest expenditure payable on it. Accordingly we set aside the order passed by Ld CIT(A) on this issue and restore the same to the file of the AO for examining this issue afresh in the light of discussions made supra. Since we have restored this issue, we also restore the issue of the head of income under which the interest income is assessable also to the file of the AO, as the same is connected issue.

In the result, both the appeals of the assessee are treated as partly allowed for statistical purposes.