2019 (4) TMI 2191 - AT - Income Tax

Foreign exchange translation, interest disallowance, Section 14A applicability and tax-sparing credit under India-Cyprus DTAA explained with outcomes

Claim for recognition of foreign currency monetary item translation gains under accounting standards was held inconsistent with the income-tax provision ... Computation of income - gains on foreign exchange translation to tax - assessee had claimed deduction of a sum under the head ‘Foreign Currency Monetary Item Translation Difference Account’ - assessee submitted that as per the provisions of Accounting Standard-11 (AS-11), issued by the Institute of Chartered Accountants of India (ICAI), the effect of changes in foreign exchange rates, insofar as they relate to the recognition of losses or gains arising on re-statement of long term foreign currency monetary items should be recognized - assessee seeks to contend that Section 43A of the Act would apply only when capital assets are acquired outside India from and out of foreign currency loan and consequent to fluctuation of foreign currency, the liability to repay the said loan would either increase or decrease - HELD THAT:- We find that the claim made by the assessee was contrary to the provisions of Section 43A of the Act and in the circumstances, the Revenue authorities were justified in rejecting the claim of assessee. The argument that similar gain was offered to tax in the earlier assessment years will not be a ground to accept the claim of assessee in the present assessment year. We therefore concur with the view of the CIT(A) and dismiss the relevant ground of appeal of assessee. Disallowance of interest u/s. 36(1)(iii) - AO was of the view that borrowed funds on which interest was paid had been diverted for non-business purposes and he accordingly worked out proportionate disallowance of interest claimed a deduction by the assessee - HELD THAT:- It has been held in the case of CIT Vs. Reliance Utilities & Power Ltd. [2009 (1) TMI 4 - BOMBAY HIGH COURT] that if the own funds of the assessee are more than the interest free advances given to the sister concern, then, there is a presumption that interest free funds were used for giving loans to sister concerns and therefore no disallowance of interest paid on borrowings can be made. As we have already stated in the application filed for admission of additional evidence, which has been rejected by us, the assessee has sought to file evidence to show that funds given to the sister concern were out of own funds. Without going into the correctness of that claim, we are satisfied that in the given facts and circumstances of the case, the interest free funds available with assessee was sufficient at all material point of time when loans were advanced to the subsidiary company and hence disallowance of interest u/s. 36(1)(iii) of the Act cannot be sustained and the same is directed to be deleted. Disallowance of expenses invoking the provisions of Section 14A - absence of exempt income - HELD THAT:- When there is no exempt income, provision of section 14 of the Act cannot be applied. See M/S. UB INFRASTRUCTURE PROJECTS LIMITED [2017 (12) TMI 1749 - ITAT BANGALORE] Tax sparing credit - Article 25 of the India-Cyprus DTAA - Entitlement to tax sparing credit under Article 25(4) of the India-Cyprus DTAA for dividend income exempt in Cyprus - DTAA's between Contracting States which given join the Residence Country to give credit not only for Taxes actually paid in the Source Country but also for Taxes which would have been paid but for the Tax Incentives granted in the Source Country's Domestic Law - HELD THAT:- As rightly held by the CIT(A) in the order for AY. 2008-09, the implication of the phrase ‘to promote economic development’ in ordinary parlance refers to sustainable increase in living standards that delivers increase per capital income, better education and health as well as environmental protection. The public policy of any State aim sat continuous and sustained economic growth and expansion of national economics so that ‘developing countries’ become ‘developed countries’. Hence the phrase ‘to promote economic development' would imply measures undertaken to further/bolster the cause of increasing the standard of living of the people by means of sustained growth. Attracting and encouraging new businesses is definitely a took to implement the cause of economic development and giving incentives in the nature of exemption from liability to tax in r/o dividends is a very elementary method by which resources could be garnered to be invested in new business etc., thereby promoting economic growth and development. The rationale for providing exemption by itself is proof that it was for no other purpose other than to promote economic activity and hence economic development. We agree with the foresaid reasoning and find no grounds interfere with the order of CIT(A). Consequently, Ground No. 4 raised by the Revenue is dismissed. Issues: (i) Whether deduction claimed by the assessee of Rs.5,23,38,266 under 'Foreign Currency Monetary Item Translation Difference Account' is allowable or is to be disallowed under Section 43A of the Income-tax Act, 1961; (ii) Whether disallowance of interest paid (partially) under Section 36(1)(iii) for diversion/parking of borrowed funds to sister concerns is sustainable; (iii) Whether disallowance under Section 14A is sustainable where no exempt income arises and whether tax sparing credit under Article 25(4) of the India-Cyprus DTAA is allowable.Issue (i): Deductibility of foreign exchange monetary item translation difference claimed by the assessee.Analysis: The issue concerns whether the forex translation difference relating to foreign currency borrowings used for acquisition of capital assets can be claimed as deduction in the year of fluctuation or must be addressed under Section 43A on payment. The authorities applied Section 43A and relevant accounting treatment and examined the factual position of acquisition and treatment in prior years; the assessee sought to file additional evidence and to rely on a changed factual stance that assets were indigenously purchased.Conclusion: Against the assessee. The claim for deduction is disallowed under Section 43A; the application for additional evidence and for raising the new ground is refused and the assessee's ground is dismissed.Issue (ii): Disallowance of interest under Section 36(1)(iii) on the ground that borrowed funds were diverted to interest-free advances to sister concerns.Analysis: The assessment of whether borrowed funds were used for non-business purposes involved evidence of availability of own funds, tracing of advances and absence of separate accounts for interest-bearing versus interest-free funds. The Tribunal applied the presumption that where own funds exceed advances, advances are presumed to be from own funds and considered precedent authority on this principle.Conclusion: In favour of the assessee. The Tribunal deleted the disallowance of interest under Section 36(1)(iii) on the basis that the assessee had sufficient own funds and the disallowance could not be sustained.Issue (iii): Validity of disallowance under Section 14A where no exempt income arises and entitlement to tax sparing credit under Article 25(4) of the India-Cyprus DTAA.Analysis: The question of Section 14A applicability was examined against the settled proposition that no disallowance under Section 14A can be made if no exempt income is earned in the relevant year. The tax sparing credit issue required interpretation of Article 25(4) of the DTAA and whether the Cyprus exemption qualified as an incentive 'designed to promote economic development'; previous appellate findings on identical facts for an earlier year were considered and applied for consistency.Conclusion: In favour of the assessee. The Tribunal upheld deletion of any Section 14A addition for lack of exempt income and affirmed allowance of tax sparing credit under Article 25(4) of the DTAA as correctly accepted by the CIT(A), dismissing Revenue's ground on the DTAA matter.Final Conclusion: The Tribunal partly allowed the assessee's appeal by deleting the interest disallowance under Section 36(1)(iii) and upholding the allowance of tax sparing credit and deletion of any Section 14A disallowance, while rejecting the assessee's claim for deduction of the forex translation difference under Section 43A; the Revenue's appeal was dismissed.Ratio Decidendi: Section 14A disallowance cannot be invoked where no exempt income arises in the relevant year; where own funds exceed the advances to related concerns, a presumption arises that advances were out of own funds and interest disallowance is not sustainable; tax sparing credit under Article 25(4) of the DTAA is allowable where the exemption in the source state serves to promote economic development.