Corporate guarantee and foreign exchange loss issues: no ALP adjustment, no 14A disallowance without exempt income, business loss allowed.

Corporate guarantee to an overseas associated enterprise was held not to require an arm's length price adjustment on the facts, and the amendment to section 92B was treated as not changing that position for the controversy. Section 14A read with rule 8D could not be applied where no exempt income had been earned, so the related MAT adjustment under section 115JB also failed. Foreign exchange loss on cancellation and revaluation of forward contracts and foreign currency business loans was treated as revenue in nature because the contracts hedged business risk and the borrowings were for business purposes, making the loss deductible under section 37(1).

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Issues: (i) Whether the arm's length price adjustment relating to corporate guarantee given to an overseas associated enterprise was sustainable; (ii) Whether disallowance under section 14A read with rule 8D and the related computation under section 115JB could be made in the absence of exempt income; (iii) Whether foreign exchange loss on cancellation and revaluation of forward contracts and foreign currency business loans was allowable as revenue expenditure.

Issue (i): Whether the arm's length price adjustment relating to corporate guarantee given to an overseas associated enterprise was sustainable;

Analysis: The adjustment had been made on the premise that corporate guarantee constituted an international transaction. The finding upheld by the Tribunal was that corporate guarantee, in the facts of the case, did not warrant such adjustment, following the approach adopted in earlier assessment years and the view that the amendment to section 92B did not alter the position for the present controversy.

Conclusion: The issue was decided in favour of the assessee and the ALP adjustment was deleted.

Issue (ii): Whether disallowance under section 14A read with rule 8D and the related computation under section 115JB could be made in the absence of exempt income;

Analysis: The disallowance under section 14A was held to be inapplicable where no exempt income had been earned. Since the foundational disallowance itself did not survive, the consequential adjustment under section 115JB also could not stand. The Tribunal relied on the settled position that section 14A cannot operate without exempt income and that the MAT computation could not be enhanced on that basis.

Conclusion: The issue was decided in favour of the assessee and both the section 14A disallowance and the consequential section 115JB adjustment were rejected.

Issue (iii): Whether foreign exchange loss on cancellation and revaluation of forward contracts and foreign currency business loans was allowable as revenue expenditure;

Analysis: The loss was found to be and incurred in the ordinary course of import-export business. The Tribunal accepted that the forward contracts were entered into to hedge exchange fluctuation risk, that the foreign currency loans were taken for business purposes and not for acquiring capital assets, and that accounting principles required recognition of exchange differences at the year-end. The ruling followed the principle that such loss, when attributable to business transactions and supported by the books and bank records, is deductible as revenue expenditure.

Conclusion: The issue was decided in favour of the assessee and the foreign exchange loss was held allowable under section 37(1).

Final Conclusion: The Revenue's appeal failed on all substantive grounds and the relief granted by the first appellate authority was sustained.

Ratio Decidendi: A business loss arising from foreign exchange fluctuation on revenue transactions, including hedging contracts and foreign currency borrowings used for business, is deductible when it is real and incurred wholly for business purposes; similarly, section 14A disallowance cannot be made in the absence of exempt income.

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