Exempt-income requirement limits Section 14A disallowance, while genuine loan-hedging swap losses recognised under accounting standards remain deductible.

Section 14A read with Rule 8D does not support expenditure disallowance where no exempt income is earned or claimed. Consequently, a corresponding adjustment to book profit under Section 115JB(2) does not arise where the Section 14A disallowance fails, particularly when book profit is negative. The notes also address mark-to-market losses on foreign-currency swap contracts used to reduce borrowing costs: where the loss is consistently recognised under Accounting Standard-11, with corresponding gains offered to tax, exchange fluctuation on outstanding contracts is treated as an accrued liability rather than a contingent or hypothetical loss and is deductible.

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Issues: (i) Whether disallowance of expenditure under Section 14A read with Rule 8D was permissible where no exempt income was earned or claimed; (ii) Whether an adjustment to book profit under Section 115JB(2) survived in respect of such disallowance; (iii) Whether mark-to-market loss on foreign-currency swap contracts entered to reduce borrowing costs was deductible.

Issue (i): Whether disallowance of expenditure under Section 14A read with Rule 8D was permissible where no exempt income was earned or claimed.

Analysis: The assessee neither earned exempt income nor claimed any exemption during the relevant assessment year. The Tribunal's deletion of the disallowance followed the jurisdictional principle that Section 14A cannot operate where no exempt income is earned or claimed.

Conclusion: Disallowance under Section 14A read with Rule 8D was not permissible; the issue was decided in favour of the assessee.

Issue (ii): Whether an adjustment to book profit under Section 115JB(2) survived in respect of such disallowance.

Analysis: Since no disallowance under Section 14A remained and the book profit was negative, the proposed adjustment under the MAT provisions did not arise.

Conclusion: No adjustment to book profit under Section 115JB(2) was warranted; the issue was decided in favour of the assessee.

Issue (iii): Whether mark-to-market loss on foreign-currency swap contracts entered to reduce borrowing costs was deductible.

Analysis: The swap contracts converted rupee loans into foreign-currency loans to secure lower interest costs. The loss was consistently recognised in accordance with Accounting Standard-11, while corresponding gains were offered to tax. The loss from exchange fluctuation on outstanding contracts was an accrued and subsisting liability, not a contingent or hypothetical loss.

Conclusion: Mark-to-market loss on the foreign-currency swap contracts was deductible; the issue was decided in favour of the assessee.

Final Conclusion: No substantial question of law arose on any of the substantively considered issues, and the Tribunal's relief was sustained.

Ratio Decidendi: Expenditure disallowance under Section 14A requires exempt income, and mark-to-market foreign-exchange loss on a genuine loan-hedging swap, consistently accounted for under the applicable accounting standard, is an accrued deductible liability rather than a contingent loss.

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