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Income Tax Appellate Tribunal, “E” BENCH, MUMBAI
These four appeals of different assessee filed by the Revenue are arising out of the different orders of Commissioner of Income Tax (Appeals)-8, Mumbai [in short CIT(A)], in appeal No. CIT(A)-8/IT- 297,391,273,194/15-16, dated 20.12.2016, 27.12.2016, 29.12.2016. The Assessments were framed by the Dy. Commissioner of Income Tax, Circle-3(1)(2), Mumbai (in short ‘DCIT/ AO’) for the A.Y. 2012-13 vide order dated 25.03.2015, 30.03.2015, 21.03.2015 under section 143(3) of the Income Tax Act, 1961 (hereinafter ‘the Act’). The rectification order Passed by DCIT/AO in the case of Edelweiss Investment Advisors Pvt. Ltd. vide order dated 15.06.2015 under section 154 of the Act.
The first common issue in all these four appeals of Revenue of different assessee is against the order of CIT(A) deleting the disallowance made by AO on loss claimed on mark to market on account of trading of derivative instruments by treating the same as notional loss and treating the same as contingent liability. For all these four appeals, Revenue has raised identical grounds, facts are also identical in all the four appeals and hence, we will take up the facts from ITA No.
ITA Nos. 2635-2638/Mum/2017 2636/Mum/2017 in the case of ECAP equities Ltd. The relevant ground No.1 reads as under: -
“1. Whether ld. CIT(A) is erred in allowing the provision for mark to market on trading of derivative instruments by treating it as notional loss without appreciating the fact that the contingent liability cannot be deductible under income tax act."
Briefly stated facts are that the assessee is engaged in the business of share broking and trading, advisory, investing. During the course of assessment proceedings, the AO noticed that the assessee has claimed loss on account of provision made for mark to market loss as under: -
Particulars Amount (Rs) Index Future 8,043 Currency Future 16,29,431 Equity future 17,27,51,118 Total 17,43,88,592 4. The AO noted that the assessee has claimed deduction on account of provision for loss on index option, currency future, equity future amounting to ₹ 17,43,88,592/-. The assessing officer requested the assessee to furnish the details of mark to market profit/ loss it had incurred while trading in commodities especially future options. The assessee filed complete details and stated that it had incurred mark to market loss while trading in commodities i.e. future and equities and the same has been debited in the accounts of the assessee. According to AO, this mark to market loss are notional loss and therefore not allowable as deduction in view of CBDT instruction dated 23.03.2010 and also relied on Sanjeev Woolen Mills vs. CIT 279 ITR 434 (SC). The AO has not doubted the genuineness of transactions but only that this is ITA Nos. 2635-2638/Mum/2017 unascertained liability and merely provision and hence cannot be allowed. Aggrieved, assessee preferred the appeal before CIT(A). The CIT(A) after going through the facts of the case and various decision of the ITAT in assessee’s own case allowed the claim of assessee by observing in Para 5.2 as under: -
“5.2. Ground No. 2
5.2.1 This ground relates to disallowance of provision for loss of ₹ 17,43,88,592/- being mark market loss on trading in INDEX OPTION, EQUITY FUTURES AND CURRENCY FUTURES as non- ascertainable liability under section. 115JB Explanation 1 clause (c). The Assessing Officer has discussed this at Para 4 of his order. I find that this issue has been decided by me in other Edelweiss group companies viz. Edelcap Securities Ltd. (AY 2011-12, Apepal No. CIT(A)-8/IT-596/14-15 order dt. 16.03.2016) and Edelweiss Trading & Holding Ltd. (AY 2011-12, Appeal No. CIT(A)-8/IT-590/14 order dt. 16.03.2016) with similar facts and circumstances. The relevant extract of the latter decision is as below:
5.2.2 I find this is covered issue in favour of the appellant in jurisdictional Mumbai ITAT in the following cases relied upon by the appellant:
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ITA Nos. 2635-2638/Mum/2017
5.2.3 In view of the direct decisions on the issue from jurisdictional ITAT, the disallowance of ₹ 12,74,59,362/- made on this account is deleted. This ground of appeal is allowed.
5.2.2. In consonance with my decisions above and respectfully following the decision of jurisdictional courts, disallowance of ₹ 17,43,88,592/- is deleted. This ground is allowed.”
Aggrieved, now Revenue is in appeal before us.
We have heard the rival contentions and gone through the facts and circumstances of the case. We find from the facts of the case that the assessee entered into transaction for purchase and sale of derivative futures/ option on stock exchanges. The transactions which are settled during the year and the difference between contract price and settled price being profit/loss are recognized in the books of accounts maintained by the assessee. Outstanding derivative contracts in the nature of futures/options are measured at fair value as at the balance sheet date. Fair value is determined using quoted market prices in an actively traded market, for the instrument, wherever available, as the best evidence of fair value. In the absence of quoted market prices in an actively traded market, a valuation technique is used to determine the fair value. The margin money paid/received on derivative contract relating to purchase (long position) and sale (short position) of options in respect of outstanding position as on Balance Sheet dated (i.e. 31.3.2012) are shown as margin paid / received on derivatives and same are grouped under current assets / current liabilities respectively. The assesee company has accounted for the loss/ gain from derivatives instruments following the principles laid down in Accounting Standard 30 - "Financial
ITA Nos. 2635-2638/Mum/2017 Instruments Recognition and Measurement (AS 30)" and Guidance Note on accounting for Equity Index and Equity Stock Futures and Options issued by the Institute of Chartered Accountants of India (ICAI). Subsequent to initial recognition, the derivatives are measured at fair value prevailing on the last day of the financial year and any changes therein are accounted in profit and loss account. In view of these facts and the Tribunal taking a consistent view in assessee’s own cases that this derivative loss is to be allowed, we are of the view that this issue is squarely covered in favour of assessee.
We also find that this issue is squarely covered by the decision of Hon’ble Supreme Court in the case of CIT vs. woodward Governor India (P) Ltd. 312 ITR 254 (SC), wherein Hon’ble Supreme Court has decided the issue as under: -
“14. In the case of M.P. Financial Corporation v. CIT [1987] 165 ITR 765 the Madhya Pradesh High Court has held that the expression "expenditure" as used in section 37 may, in the circumstances of a particular case, cover an amount which is a "loss" even though the said amount has not gone out from the pocket of the assessee. This view of the Madhya Pradesh High Court has been approved by this Court in the case of Madras Industrial Investment Corpn. Ltd. v. CIT [1977] 225 ITR 802 . According to the Law and Practice of Income-tax by Kanga and Palkhivala, section 37(1) is a residuary section extending the allowance to items of business expenditure not covered by sections 30 to 36. This section, according to the learned Author, covers cases of business
ITA Nos. 2635-2638/Mum/2017 expenditure only, and not of business losses which are, however, deductible on ordinary principles of commercial accounting. (see page 617 of the eighth edition). It is this principle which attracts the provisions of section 145. That section recognizes the rights of a trader to adopt either the cash system or the mercantile system of accounting. The quantum of allowances permitted to be deducted under diverse heads under sections 30 to 43C from the income, profits and gains of a business would differ according to the system adopted. This is made clear by defining the word "paid" in section 43(2), which is used in several sections 30 to 43C, as meaning actually paid or incurred according to the method of accounting upon the basis on which profits or gains are computed under section 28/29. That is why in deciding the question as to whether the word "expenditure" in section 37(1) includes the word "loss" one has to read section 37(1) with section 28, section 29 and section 145(1). One more principle needs to be kept in mind. Accounts regularly maintained in the course of business are to be taken as correct unless there are strong and sufficient reasons to indicate that they are unreliable. One more aspect needs to be highlighted. Under section 28(i), one needs to decide the profits and gains of any business which is carried on by the assessee during the previous year. Therefore, one has to take into account stock- in-trade for determination of profits. The 1961 Act makes no provi- sion with regard to valuation of ITA Nos. 2635-2638/Mum/2017 stock. But the ordinary principle of commercial accounting requires that in the P&L account the value of the stock-in-trade at the beginning and at the end of the year should be entered at cost or market price, whichever is the lower. This is how business profits arising during the year needs to be computed. This is one more reason for reading section 37(1) with section 145. For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant. This is because profits/loss is embedded in the closing stock. While anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as no prudent trader would care to show increase profits before actual realization. This is the theory underlying the Rule that closing stock is to be valued at cost or market price, whichever is the lower. As profits for income-tax purposes are to be computed in accordance with ordinary principles of commercial accounting, unless, such principles stand superseded or modified by legislative enactments, unrealized profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the following years account in a continuing business are not brought to the charge as a matter of practice, though, as stated above, loss due to fall in the price below cost is allowed even though such loss has not been realized actually. At this stage, we need to emphasise once again that the above system of ITA Nos. 2635-2638/Mum/2017 commercial accounting can be superseded or modified by legislative enactment. This is where section 145(2) comes into play. Under that section, the Central Government is empowered to notify from time to time the Accounting Standards to be followed by any class of assessees or in respect of any class of income. Accordingly, under section 209 of the Companies Act, mercantile system of accounting is made mandatory for companies. In other words, accounting standard which is continuously adopted by an assessee can be superseded or modified by Legislative intervention. However, but for such intervention or in cases falling under section 145(3), the method of accounting undertaken by the assessee continuously is supreme. In the present batch of cases, there is no finding given by the Assessing Officer on the correctness or completeness of the accounts of the assessee. Equally, there is no finding given by the Assessing Officer stating that the assessee has not complied with the accounting standards.”
In view of the above discussion and the fact that the assessee is booking profits on derivatives as and when it is valued at the end of the year and as and when the loss is arising, the same is claimed as deduction. This practice is followed by assessee regularly and Tribunal in assessee’s own case in immediate preceding year i.e. AY 2011-12 as allowed the claimed of the assessee, respectfully following the same, we allow the claim of the assessee. This issue is exactly identical in these four appeals of Revenue, hence, taking a consistent view, we dismiss this issue of Revenue’s appeals.
ITA Nos. 2635-2638/Mum/2017
The second issue only in in the case of ECAP equities Ltd. is as regards to the order of CIT(A) deleting the disallowance of expenses relatable to exempt income by the AO by invoking the provisions of Section 14A of the Act read with Rule 8D(2)(ii) & (iii) of the Rules. For this Revenue has raised the following ground No 2: -
“2. Whether ld. CIT(A) is erred in deleting the disallowance made under section 14A of the act without appreciating the fact that the assessee has neither established that no part of interest-bearing fund as well as expenses so claimed has found its way into the investments nor adduced any documentary evidences during the course of assessment proceedings before the AO."
Brief facts of the case are that the AO during the assessment proceedings noticed that the assessee has earned dividend income of ₹ 50,62,962/- on shares and ₹ 7,75,804/- on mutual funds and claimed the same as exempt income under section 10(34) and 10(35) of the Act respectively. The assessee suo moto disallowed a sum of ₹ 73,281/- being expenses incurred for earing of exempt income under section 14A read with Rule 8D of the Rules. The AO noted that the disallowance made by the assessee is not in term of the provisions of the Act and therefore, he recomputed the disallowance under Rule 8D(2) (ii) at ₹ 2,91,50,899/- and under Rule 8D(2)(iii) being an average value of investment at 0.5% amounting to ₹ 27,93,971/-. Thereby, the AO re- computed the disallowable expenses at ₹ 3,19,44,870/- and after considering the suo moto disallowance of ₹ 73,281/-, he made actual disallowance of ₹ 3,18,71,589/-. Aggrieved, assessee preferred the appeal before CIT(A), the CIT(A) restricted the disallowance at Rs.
ITA Nos. 2635-2638/Mum/2017 72,281/- i.e. suo moto disallowance made by assessee. Aggrieved now Revenue is in appeal before Tribunal.
We have heard the rival contentions and gone through the facts and circumstances of the case. As regards the disallowance made by AO and deleted by CIT(A) in regard to interest expenses at ₹ 2,91,50,899/-. Before us, assessee contended that assessee’s own fund in the form of share capital and reserves are to the tune of ₹ 194,60,64,665/- as against the total investment made in equity shares and mutual funds is to the tune of ₹ 4,85,91,736/-. The assessee has filed a complete details of chart as under: - A) Net Interest of the assessee
Particulars Amount Interest expenses as per note 2.22 of 204,955,596 audited financial statement Less: Interest income as per note 2.19 313,85,456 of audited financial statement Net interest expenses/ (income) 108,869,860 B) Statement showing own fund of the assessee
Particulars Amount Share capital Reserve and Surplus 20,400,000 Reserves and Surplus 1,925,664,665 Total(A) 1,946,064,665 Investment/ stock in trade Non-Current investment 11,402,000 Current Investment 690,162 Stock in trade Equity Shares 2,437,584 Mutual Funds 9,766,122 12,203,706 Total(B) 24,295,868 Own fund in excess of investment and 1,921,768,797 stock in trade (A-B) 11. We find that the CIT(A) has deleted the interest disallowance for the reason that the assessee’s own funds in the form of share capital and ITA Nos. 2635-2638/Mum/2017 reserve are more than the investment in giving tax free income. Once this is the position, the issue is squarely covered by following the decision of Hon’ble Bombay High Court in the case of CIT vs. HDFC Bank Ltd. (2014) 366 ITR 505 (Bom). Respectfully following the Bombay High Court decision and considering the facts of the case, we are of the view that the CIT(A) has rightly deleted the addition and we confirm the same.
As regards to the disallowance of administrative expense under Rule 8D(2)(iii) of the Income Tax Rules, the assessee has filed the details of investment and dividend income earned qua that and requested that disallowance be restricted at ₹ 3,33,885/-. The assessee filed the details as under: -
C) Disallowance as per Rue 8D(2)(iii) of the Rules considering the stock in trade on which the assessee has actually earned the exempt income.
Particulars Dividend Investment/stock Investment/stock income in trade as on in trade as on 31/03/2012 31/03/2011 Edelweiss Absolute 1,124,22 9,266,122 Return Fund-Dividend- Reinvestment Edelweiss Income 775,805 22,800,447 Advantage Fund- Dividend- Reinvestment Claris Lifesciences Ltd. 1,500,000 130,800,000 Kotak Mahindra Bank 2,438,736 Ltd. 5,838,767 9,266,122 153,600,447 Average investment [₹ 92,66,122+153,600,447)/2] 81,433,284 0.5% of average investment i.e. ₹ 8,14,33,284 407,166 Disallowance already made by the Assessee 73,281 Balance amount to be disallowed 333,885
The learned Counsel for the assessee only requested that the AO can verify the investment giving exempt and investments which are kept as stock in trade can be disallowed. Apart from that the assessee has re- computed the disallowance which may be accepted. We find that the plea of the assessee is quite reasonable and hence, accordingly we restore this issue back to the file of the AO who will determine the investment held in stock in trade and he will disallow the interest only on the investments kept as stock in trade but only qua the investment giving exempt income. Accordingly, this issue of Revenue’s appeal is partly allowed for statistical purposes.
In the result, Revenue’s appeal in is partly allowed and rest of all three appeals i.e. ITA Nos. 2635,2637&2638/Mum/2017 of Revenue are dismissed. Order pronounced in the open court on 28-09-2018.