2020 (11) TMI 333 - AT - Income Tax

Tribunal rules for appellant: Notional interest, mark-to-market loss disallowed; Section 14A disallowance restricted.

S. Vinodkumar Diamonds, Pvt Ltd. Versus DCIT – 5 (3), Mumbai.

S. Vinodkumar Diamonds, Pvt Ltd. Versus DCIT – 5 (3), Mumbai. - TMI Issues Involved:1. Transfer pricing adjustment related to notional interest on export receivables.2. Disallowance of mark to market loss on forward contracts.3. Disallowance under Section 14A of the Income Tax Act.Issue-wise Detailed Analysis:1. Transfer Pricing Adjustment Related to Notional Interest on Export Receivables:The appellant argued that the order of the Transfer Pricing Officer (TPO) and the consequential assessment order were void as no written show cause notice was issued as required under Section 92C(3) of the Income Tax Act. The appellant contended that delayed realization of export sale proceeds should not be treated as a separate international transaction under Section 92B of the Act. The TPO had suggested an upward adjustment of Rs. 1.51 crore towards notional interest on delayed realization of export receivables from Associated Enterprises (AEs). The appellant argued that they did not charge interest on delayed payments from both AEs and non-AEs, and thus, the practice should be considered at arm's length. The Tribunal noted that the amendment to Section 92B by the Finance Act, 2012, was not retrospective. It was observed that the appellant had a uniform policy of not charging interest from both AEs and non-AEs, and the average delay in receivables from AEs was less than that from non-AEs. Therefore, the Tribunal concluded that no notional interest adjustment was warranted, and grounds 1 to 5 were allowed in favor of the appellant.2. Disallowance of Mark to Market Loss on Forward Contracts:The appellant, engaged in the business of importing and exporting diamonds, entered into foreign currency forward contracts to hedge against foreign exchange fluctuation risks. The appellant followed the mercantile system of accounting and AS-11, revaluing outstanding foreign currency monetary items at the closing rate as of 31st March. The Assessing Officer (AO) disallowed Rs. 2.86 crore as a notional loss, arguing that the contracts were settled after the financial year. The Tribunal referred to the Supreme Court's decision in CIT Vs. Woodward Governor India (P) Ltd., which held that such losses are not notional and are allowable as business expenditure under Section 37(1). The Tribunal also noted the Bombay High Court's decision in CIT Vs. D. Chetan & Co., which held that forward contracts for hedging purposes in the normal course of business are not speculative but business activities. Therefore, the Tribunal directed the AO to delete the disallowance, allowing grounds 6 and 7 in favor of the appellant.3. Disallowance under Section 14A of the Income Tax Act:The AO disallowed Rs. 32,62,934/- under Section 14A read with Rule 8D, attributing it to interest and indirect expenses related to exempt income. The appellant argued that no expenses were incurred for earning the exempt income, which was derived from past investments funded through their own surplus and reserves. The Tribunal noted that the appellant's reserves and surplus were significantly higher than the investments, aligning with the decisions in Reliance Utility and Power Ltd. and CIT Vs. HDFC Bank Ltd. The Tribunal also referred to the Delhi High Court's decision in Joint Investments (P.) Ltd. v. CIT, which held that disallowance under Section 14A cannot exceed the exempt income. Consequently, the Tribunal restricted the disallowance to Rs. 1.62 lakhs, the amount of exempt income earned by the appellant, and partly allowed ground 8.Conclusion:The appeal was partly allowed, with the Tribunal ruling in favor of the appellant on the issues of transfer pricing adjustment and mark to market loss disallowance, while partially allowing the disallowance under Section 14A.