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Income Tax Appellate Tribunal, “D” BENCH, MUMBAI
Before: SHRI SAKTIJIT DEY & SHRI N.K. PRADHAN
PER SAKTIJIT DEY, J.M.
Aforesaid cross appeals for assessment year 2008–09 and appeal by the Department for the assessment year 2009–10, are directed against separate orders passed by the learned Commissioner (Appeals)–6, Mumbai.
./2013 Revenue’s Appeal – A.Y. 2008–09
Grounds no.1, 2 and 3, relate to deletion of addition of an amount of ` 5,57,39,071, representing marked–to–market loss.
Brief facts are, the assessee an Indian company is a wholly owned subsidiary of DSP Merrill Lynch Ltd. It is a non–banking financial company (NBFC) and is primarily engaged in financing and lending activities. Besides, it is also engaged in trading in securities, derivative instruments and other products. In the course of assessment proceedings, the Assessing Officer after examining the accounts of the assessee noticed that it has claimed deduction of ` 5,57,39,071 on account of provisions for marked–to–market loss on open future contracts. He also found that assessee had claimed deduction of ` 3,50,57,000 being provisions for marked–to–market loss on stock–in–trade. He noticed, assessee has claimed deduction of 3 DSP Merill Lynch Capital Ltd.
` 33,21,000 on account of marked–to–market provisions on open interest rate swaps as on 31st March 2008. He, therefore, called upon the assessee to show cause why provisions for marked–to–market loss claimed on account of provisions for open equity stock future contract should not be disallowed as they are in the nature of contingent liability. In response to the show cause notice assessee submitted a detailed reply justifying its claim of deduction on account of loss. The Assessing Officer after considering the submissions of the assessee, however, did not find merit in the same. Ultimately, he concluded that marked–to–market loss should be considered as notional loss which do not involve actual outgo as the assessee is not liable to pay such losses. Referring to CBDT instructions, the Assessing Officer finally held that since the loss claimed by the assessee is in the nature of contingent liability it will not constitute a deductible expenditure. Accordingly, he disallowed the loss on equity stocks futures and options, stock–in–trade and marked–to–market loss on interest rate swap aggregating to ` 9,41,17,071. Being aggrieved of such disallowance of loss claimed, assessee preferred appeal before the learned Commissioner (Appeals).
The learned Commissioner (Appeals) after considering the submissions of the assessee, as far as marked–to–market loss on account of open equity stock, future contract amounting to `
4 DSP Merill Lynch Capital Ltd.
5,57,39,071, he followed the order of the Tribunal, Mumbai Bench, in Edelweiss Capital Ltd. v/s ITO, ITA no.5324/Mum./2007 and allowed assessee’s claim. As far as provisions for loss on stock–in–trade amounting to ` 3,50,57,000, the learned Commissioner (Appeals) following the decision of the Hon'ble Supreme Court in United Commercial Bank v/s CIT, 240 ITR 355 (SC), allowed assessee’s claim. As far as loss on provisions for interest rate swap amounting to ` 33.21 lakh learned Commissioner (Appeals) following the decision of the Tribunal, Mumbai Bench, in ABN Amro Securities India Pvt. Ltd. v/s ITO, ITA no.264/Mum./2008, allowed assessee’s claim.
Learned Departmental Representative relying upon the reasoning of the Assessing Officer submitted, loss claimed by assessee being in the nature of contingent liability is not allowable.
Learned Authorised Representative strongly supporting the order of the learned Commissioner (Appeals) submitted that the assessee is trading in derivatives. As far as marked–to–market loss on account of open equity stock future contract is concerned, he submitted, the valuation is made on the basis of actual value as existing on 31st March. Therefore, it is an ascertained liability of the assessee and cannot be considered as contingent in nature. For such proposition, he relied upon the decision of the Tribunal, Mumbai Bench, in Edelweiss
5 DSP Merill Lynch Capital Ltd.
Capital Ltd. (supra). He also relied upon the decision of the Tribunal, Mumbai Bench, in DCIT v/s Kotak Mahendra Investments Ltd., [2013] 59 SOT 4. As far as loss on account of valuation in closing stock in trade, the learned Authorised Representative submitted, in no case, it can be considered as contingent liability as it is the actual stock–in– trade of the assessee and as per the accounting principle it has to be valued at year end at cost or market rate whichever is lower. He submitted, the assessee has shown profit of ` 766 crore and the assessed profit is ` 783 crore. Therefore, it is highly improbable that assessee would be claiming loss of such a meager amount to show less income. In support of his contention, learned Authorised Representative relied upon the decision of the Hon'ble Supreme Court in United Commercial Bank (supra). As far as loss on account of provisions of interest rate swap is concerned, the learned Authorised Representative submitted, the issue is fully covered by the decision of the Tribunal, Mumbai Bench, in ABN Amro Securities India Pvt. Ltd. (supra). He, therefore, submitted no interference is called for on this issue.
We have considered the submissions of the parties and perused the material available on record. As could be seen, the Assessing Officer has disallowed assessee’s claim of loss on open equity stock future contracts primarily for the reason that they are in the nature of 6 DSP Merill Lynch Capital Ltd.
contingent liability. However, as could be seen, the Tribunal, Mumbai Bench, in Edelweiss Capital Ltd. (supra) while considering identical nature of dispute as observed in the following manner:–
“The aforesaid Note gives a fair picture of the nature of the provision. The provision in substance has been made to cover the anticipated loss in the derivates trading. There is no dispute that the assessee holds derivatives as its stock–in–trade and there is also no dispute that it follows the principle “cost or market price, whichever is lower” in valuing the derivatives. When the derivatives are held as stock–in–trade then whatever rules apply to the valuation of stock–in–trade will have to be necessarily apply to their valuation also. It is a well settled position in law that “while anticipated loss is taken into account in valuing the closing stock, anticipated profit in the shape of appreciated value of the closing stock is not brought into the account, as no prudent trader would care to show increased profit before its realization. This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is the lower, and it is now generally accepted as an established rule of commercial practice and accountancy”. This is what the Supreme Court held in the case of Chainrup Sampatram v/s Commissioner of Income Tax, West Bengal (1953) 24 ITR 481 (SC), speaking through Hon’ble Justice Patanjali Sastri, the then Chief Justice of India (Pate–485 – 486 of the Report). At page 486 the Hon'ble Supreme Court further observed that “loss due to a fall in price below cost is allowed even if such loss has not been actually realized”. Quoting from the case of Whimster & Co. v/s Commissioners of Inland Revenue (1926 12 Tax Cases 813, the Hon'ble Supreme Court observed that the profits that are chargeable to tax are those realized in the year and that an exception is recognized where a trader purchased and still holds goods which are fallen in value in which cae though no loss has been realized nor it has occurred, nevertheless at the close of the year he is permitted to treat these goods as of their market value. This decision of the Hon'ble Supreme Court governs the facts of the present case. It is to the assessee’s strength that the Institute of Chartered Accountants of India in its guidelines have also approved of the rule of prudence which really means that while anticipated losses can be taken note of while valuing the closing stock, anticipated profits cannot be recognized. The anticipated loss, in the light of the judgment of the Supreme Court cited above, cannot be treated as a contingent liability.”
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Following the aforesaid decision, the Tribunal, Mumbai Bench, in Kotak Mahendra Ltd. (supra), expressed similar view. Thus, the view expressed by the learned Commissioner (Appeals) being in consonance with the aforesaid view of the Tribunal, we do not find any reason to interfere with the order of the learned Commissioner (Appeals) on this issue.
As far as loss claimed on valuation of closing stock–in–trade, undisputedly, it is the actual stock–in–trade of the assessee which as per the accounting principles has to be valued at the year end at market rate or actual cost whichever is lower. The Hon'ble Supreme Court in United Commercial Bank v/s CIT, approved the aforesaid accounting method followed by the assessee. That being the case, the loss claimed by the assessee cannot be considered as contingent liability. As far as loss on account of provisions for interest rate swap the same is also covered by the decisions of the Tribunal in case of ABN Amro Securities (supra), wherein, the Tribunal deleted the disallowance made with the observation that allowability of deduction in the current year is subject to verification of corresponding adjustment in the year in which the non–settlement date falls. In view of the aforesaid, we delete the addition with similar observation.
8 DSP Merill Lynch Capital Ltd.
In ground no.4, Revenue has challenged partial relief granted by the learned Commissioner (Appeals) in relation to addition made under section 14A r/w rule 8D(2)(ii) and (iii).
Brief facts are, during the assessment proceedings, the Assessing Officer noticed that the assessee in the relevant previous year has earned exempt income by way of dividend amounting to ` 1,18,43,572 and long term capital gain of ` 50,05,44,706. He also noticed that the assessee has suo–motu disallowed ` 20 lakh. However, the Assessing Officer being of the view that the disallowance made by the assessee is not in terms of rule 8D, called for an explanation and after considering the submissions of the assessee disallowed an amount of ` 7,68,71,967. Being aggrieved of such disallowance, assessee preferred appeal before the learned Commissioner (Appeals).
The learned Commissioner (Appeals), after considering the submissions of the assessee granted partial relief by directing the Assessing Officer to exclude the investment held as stock–in–trade from the average value of investment to compute disallowance under section 8D(2)(ii) and (iii). Being aggrieved of the aforesaid decision of the learned Commissioner (Appeals), the Department is in appeal before the learned Commissioner (Appeals).
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We have considered the submissions of the parties and perused the material available on record. The issue raised by the Department is fully covered in favour of the assessee by the decision of the Hon'ble Jurisdictional High Court in CIT v/s India Advantage Securities Ltd., judgment dated 17th March 2015, wherein the Hon'ble Jurisdictional High Court while upholding the decision of the Tribunal held that provisions of section 14A r/w rule 8D will not be applicable to investment in shares and securities held as stock–in– trade. In view of the aforesaid decision of the Hon'ble Jurisdictional High Court, we do not find any reason to interfere with the order of the learned Commissioner (Appeals).
Ground no.5, raised by the Department is challenging the decision of the learned Commissioner (Appeals) in deleting ` 3,50,57,000 representing marked–to–market loss in stock–in–trade for computing book profit under section 115JB.
Brief facts are, the Assessing Officer holding that marked–to– market loss being unascertained liability the same cannot be allowed. Accordingly, while computing the book profit, he added back the amount to the book profit along with the other loss claimed. The learned Commissioner (Appeals), while sustaining the addition made to 10 DSP Merill Lynch Capital Ltd.
the book profit on account of other loss deleted the addition made on account of marked–to–market loss on stock–in–trade.
Learned Departmental Representative relied upon the reasoning of the Assessing Officer.
Learned Authorised Representative on the other hand, referring to Explanation 1(c) to section 115JB submitted that the loss claimed by the assessee being ascertained liability it will not come within Explanation 1(c) to section 115JB, hence, cannot be considered for computing book profit under section 115JB.
We have considered the submissions of the parties and perused the material available on record. While deciding ground no.2, of the Department in earlier part of the order, we have held that marked–to– market loss on stock in trade cannot be considered as unascertained liability Explanation 1(c) to section 115JB makes it clear that only unascertained liability can be considered for computation of book profit. That being the case, we agree with the decision of the learned Commissioner (Appeals) in deleting the addition made of ` 3.50 crore while computing book profit of the assessee.
In the result, Department’s appeal for A.Y. 2008–09 is dismissed.
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./2013 Assessee’s Appeal – A.Y. 2008–09
Ground no.1 of assessee’s appeal is on the issue of part sustenance of disallowance under section 14A r/w rule 8D.
As discussed earlier, the Assessing Officer while completing the assessment had made disallowance of ` 7,68,71,967 under section 14A r/w rule 8D.
In the appeal proceedings, the learned Commissioner (Appeals) after considering the submissions of the assessee observed that shares held as stock–in–trade amounting to ` 42,01,33,000 has to be included for the purpose of computing interest expenditure indirectly attributable towards earning of exempt income. He also directed the Assessing Officer to include interest pertaining to trading segment as unallowable interest for the purpose of rule 8D(2)(ii). Being aggrieved of the aforesaid direction of the learned Commissioner (Appeals), the assessee is in appeal before us.
The submissions of the learned Authorised Representative are three–fold. Firstly, he submitted, shares held as stock–in–trade have to be excluded for computing disallowance under section 14A. Secondly, it was submitted, the assessee had sufficient interest free surplus found available with it to make the investment, therefore, no 12 DSP Merill Lynch Capital Ltd.
disallowance of interest expenditure can be made. In this context, the learned Authorised Representative referred to the Balance Sheet of the company as at 31st march 2008. Besides, he submitted, the assessee had earned profit of ` 766 crore. Threfore, as per the decision of the Hon'ble Jurisdictional High Court in CIT v/s HDFC Bank Ltd., 366 ITR 505 (Bom.), no disallowance of interest expenditure can be made. The third submission of the learned Authorised Representative is, during the relevant previous year, assessee had earned interest income of ` 786 crore as against interest expenditure incurred of ` 521 crore. It was submitted as the assessee has positive interest income no disallowance of interest expenditure under rule 8D(2)(ii) can be made. He submitted, the only disallowance, therefore, which can be made under section 14A r/w rule 8D(2) is 0.5% on average value of investment in terms of rule 8D(2)(iii).
Learned Departmental Representative relied upon the observations of the Assessing Officer.
We have considered the submissions of the parties and perused the material available on record. As far as the disallowance of interest expenditure is concerned, we find merit in the submissions of the assessee. Firstly, shares held as stock–in–trade, have to be excluded for the purpose of computation of disallowance under section 14A.
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Secondly, as noticed from audited financial statements of the assessee for the relevant previous year, assessee is having sufficient interest free surplus fund available with it to take care of the exempt income yielding investment. Though, this fact was brought to the notice of the Departmental Authorities, however, assessee’s contention was not accepted on the reasoning that assessee failed to establish the link between the investment made and interest free fund. In our view, this cannot be a valid reason to disallow assessee’s claim in view of the principles laid down by the Hon'ble Jurisdictional High Court in HDFC Bank Ltd. (supra), wherein, it has been held that if the assessee is having funds, both interest bearing and interest free, presumption would be the investments in shares is out of interest free funds. Moreover, the assessee has demonstrated that the interest income earned during the relevant previous year far exceeds the interest expenditure. Therefore, as per the decision of the Tribunal, Mumbai Bench, in Four Dimensions Securities India Ltd. v/s ACIT, ITA no.6935/Mum./2011 dated 12th June 2013, for computing disallowance under rule 8D, only the net interest has to be considered which in the present case, is in the negative as the assessee has a positive interest income. Therefore, considering the aforesaid facts, we are of the opinion that no disallowance of interest expenditure under rule 8D(2)(ii) can be made. Therefore, only disallowance which can be 14 DSP Merill Lynch Capital Ltd. made is under rule 8D(iii), i.e., 0.5% of the average value of investment. In this regard, we must make it clear that the shares held as stock–in–trade have to be excluded from the average value of investment while computing the disallowance under rule 8D(2)(iii). We direct the Assessing Officer to compute the disallowance accordingly. Ground no.1, is partly allowed.
In ground no.2, assessee has challenged the decision of the learned Commissioner (Appeals) in upholding the addition of marked– to–market loss on equity futures amounting to ` 5,57,39,071 and provisions of loss on account of net accrued payable on interest rate swap amounting to ` 33,21,000. As discussed earlier, the learned Commissioner (Appeals) has upheld the additions of the aforesaid amounts to book profit under section 115JB on the reasoning that they are unascertained liabilities as per Explanation–1, clause (c) of section 115JB. However, while deciding Department’s appeal, we have held that these two amounts cannot be considered as unascertained liabilities of the assessee, therefore, cannot be included for computation of book profit under section 115JB. Ground no.2, is allowed.
In the result, assessee’s appeal for A.Y. 2008–09 is partly allowed.
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./2014 Revenue’s Appeal – A.Y. 2009–10
Grounds no.1 and 2 are on the issues of allowance of assessee’s claim of marked–to–market loss on open equity stock future contract and provision for marked–to–market loss on stock–in–trade.
These issues are similar to the issues raised by the Department in grounds no.1 and 2 in its appeal being ITA no.2600/Mum./2013, for A.Y. 2008–09. Following our decision in Para–7 and 8 of this order, we dismiss the grounds no.1 and 2, raised by the Department.
Ground no.3, is in relation to deletion of addition made of ` 1,18,58,639, under section 14A.
Brief facts are, during the assessment proceedings, the Assessing Officer noticed that the assessee had earned exempt income by way of dividend of ` 51.10 lakh and has disallowed amount of ` 24 lakh under section 14A towards expenditure incurred for earning exempt income. The Assessing Officer, however, did not accept the disallowance made by the Assessing Officer and proceeded to compute disallowance under section 14A r/w rule 8D independently which worked out to ` 1,42,58,639 and after reducing therefrom disallowance made by the assessee of ` 24 lakh the net disallowance made was ` 1,18,58,639.
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Being aggrieved of such disallowance, assessee preferred appeal before the first appellate authority.
The learned Commissioner (Appeals), after considering the fact that during the relevant previous year, the assessee had earned interest income of ` 424.55 crore as against interest expenditure of ` 170.34 crore, hence, the net interest expenditure works out to negative figure of (–)254.21 crore, directed the Assessing Officer to delete the addition in case there is no interest expenditure on net basis.
We have considered the submissions of the parties and perused the material available on record. The issue before us is, while computing disallowance under section 14A r/w rule 8D, whether the net interest figure should be taken. Undisputedly, in the present case material on record demonstrate that the net interest expenditure is a negative figure. Therefore, following the decision of the co–ordinate bench in Four Dimensions Securities India Ltd. (supra), we uphold the order of the learned Commissioner (Appeals) on this issue. Ground no.3, is dismissed.
Ground no.4, raised by the Department is identical to ground no.5 raised by the Department in its appeal being ITA no.2600/Mum./2013 for assessment year 2008–09. Following our
17 DSP Merill Lynch Capital Ltd. decision in Para–17, we dismiss ground no.4, raised by the Department.
In ground no.5, the Department has challenged the decision of the learned Commissioner (Appeals) in deleting the addition made to book profit on account of disallowance under section 14A r/w rule 8D.
This ground is consequential to ground no.3. While deciding ground no.3, we have upheld the order of the learned Commissioner (Appeals) in deleting the disallowance made under section 14A. Therefore, the addition to book profit under section 115JB cannot survive. We, therefore, uphold the order of the learned Commissioner (Appeals) on this issue.
In the result, Revenue’s appeal for A.Y. 2009–10 is dismissed.
To sum up, Department’s appeal in ITA no.2600/Mum./2013 is dismissed; assessee’s appeal in ITA no.2361/Mum./2013 is partly allowed; and Revenue’s appeal in ITA no.5404/Mum./2014 is dismissed. Order pronounced in the open Court on 21.12.2016