Tribunal allows marked to market loss on derivatives, partially allows disallowance, no fresh adjudication

The Tribunal allowed the assessee's claim of Rs. 5,96,510/- representing marked to market loss on derivatives, recognizing it as a genuine loss under Section 37(1) of the Income Tax Act. The disallowance under Section 14A was partly allowed, with directions to the Assessing Officer to verify and compute the administrative expenditure disallowance. The appeals for the assessment year 2007-08 were partly allowed as per the earlier Tribunal order, with no requirement for fresh adjudication.

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Issues Involved:
1. Disallowance of Rs. 5,96,510/- representing marked to market loss on derivatives.
2. Disallowance under Section 14A of the Income Tax Act.
3. Fresh adjudication of issues for assessment year 2007-08 and 2008-09.

Detailed Analysis:

1. Disallowance of Rs. 5,96,510/- Representing Marked to Market Loss on Derivatives:
The assessee, engaged in shares and stock broking, trading in debt securities, mutual funds distribution, and other financial services, filed its return of income declaring a loss under normal provisions and book profit under Section 115JB of the Income Tax Act. During the assessment, the Assessing Officer (AO) noticed a loss on trading in derivative transactions and questioned whether this included any provision for loss on outstanding derivative contracts as of 31.03.2008. The assessee confirmed that the loss included a mark to market loss of Rs. 5,96,510/- on outstanding derivative contracts, justified by the accounting guidelines prescribed by the Institute of Chartered Accountants of India (ICAI). The AO, however, treated this as notional loss and disallowed it, a decision upheld by the Commissioner of Income Tax (Appeals) [CIT(A)].

The Tribunal, after considering the rival submissions and various case laws, concluded that the derivative transactions were carried out through recognized stock exchanges (NSE) and thus should not be treated as speculative transactions under Section 43(5)(d) of the Act. The Tribunal also noted that the mark to market loss is allowable under Section 37(1) of the Act, as established by the Supreme Court in CIT Vs. Woodward Governor India Pvt Ltd. Consequently, the Tribunal allowed the assessee's claim of Rs. 5,96,510/-.

2. Disallowance under Section 14A of the Income Tax Act:
The AO noticed that the assessee earned exempt income by way of dividends and disallowed an amount under Section 14A towards expenditure attributable to earning the dividend income. The AO computed the disallowance by applying Rule 8D, resulting in a significant disallowance, which was partly sustained by the CIT(A).

The Tribunal observed that the assessee had sufficient interest-free funds available and that the borrowed funds were specifically for investment in debt securities, which are not exempt income-yielding assets. The Tribunal directed that no part of the interest expenditure could be attributed to earning exempt income and that only administrative expenditure under Rule 8D(2)(iii) should be disallowed. The Tribunal also instructed the AO to verify the assessee's working of disallowance and compute it accordingly.

3. Fresh Adjudication of Issues for Assessment Year 2007-08 and 2008-09:
The Tribunal's consolidated order for the assessment years 2007-08 and 2008-09 was challenged by both parties before the Hon’ble Jurisdictional High Court. The High Court restored the issues for the assessment year 2008-09 for fresh adjudication by the Tribunal. However, the High Court inadvertently referred to the appeal number for the assessment year 2007-08 instead of 2008-09. The Tribunal clarified that the order for the assessment year 2007-08 remained intact and required no fresh adjudication. The Tribunal disposed of the appeals for statistical purposes in terms of the earlier order.

Conclusion:
- The assessee's appeal regarding the marked to market loss on derivatives was allowed, recognizing it as a genuine loss under Section 37(1).
- The disallowance under Section 14A was partly allowed, with directions to the AO to verify and compute the administrative expenditure disallowance.
- The appeals for the assessment year 2007-08 were partly allowed as per the earlier Tribunal order, with no need for fresh adjudication.

Result:
- ITA No. 456/Mum/2012: Partly allowed.
- ITA No. 660/Mum/2012: Dismissed.
- ITA Nos. 225 & 229/Mum/2011: Partly allowed.

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