By TIOL News Service

MUMBAI, MAR 30, 2016: THE issue is - Whether when entire interest-free advances were given to the subsidary company out of commercial expediency, any disallowance of interest expenditure on proportionate basis is warranted. NO is the answer.

Facts of the case

A) The assessee filed its return declaring loss under the normal provisions of the Act and book profit u/s 115JB. The case was selected for scrutiny and notices u/s 143(2) and 142(1) were issued to the assessee. AO during the course of assessment proceedings, noticed that the assessee had earned certain exempt income not forming part of the total income of the assessee and failed to disallow expenses attributable to the earning of exempt income as covered by the provision of section 14A of the Act read with Rule 8D. AO made disallowance u/s 14A r.w. rule 8D. CIT(A) deleted disallowance.

B) AO found that the assessee had raised money from secured and unsecured loans and failed to add back the interest attributable to the money which was advanced to the other entities without charging any interest from them. AO made disallowance on account of diversion of interest bearing loans to the subsidiary companies of the assessee which were held to be advances by the assessee not out of commercial expediency and for genuine business needs but merely to divert the interest bearing funds of the companies. CIT(A) deleted the addition.

C) AO found that during the year the assessee had claimed a sum in the profit and loss account under the head "Cash P/L on Options" which was on account of "Marked to market" loss on option of derivatives comprising of a sum being actual loss on of option of derivatives on those contracts which materialized within the year and further sum being provisions for MTM on options at the exchange rate on the reporting date or at the close of the year on those contracts which were due to be matured after the close of the year at the exchange rate prevalent on the closing date or reporting date. AO disallowed the same and added the same to the total income of the assessee by holding that the said losses were speculative and contingent in nature and covered by the provisions of section 43(5)(d). CIT(A) deleted the disallowance.

Having heard the parties, the ITAT held that,

A)+ assessee's own funds were far more than the investment made in the subsidiary companies and debentures. The facts are proved by the increase in reserve and surplus over the years which were at Rs.414 crores as on 31.3.2008 against the investment in subsidiaries which stood Rs.319.43 crores as on 31.3.2008. Assessee had taken loans from Financial Institutions amounting to Rs.722.24 crores, out of which the working capital loan Rs.258.79 crores and remaining pertains to term loans for the specific purposes. The AO took the entire interest debited to the profit and loss account amounting to Rs.94.35 crores and worked out the disallowance accordingly. CIT(A) had rightly deleted the disallowance on account of interest under rule 8D(2)(ii) of the Rules and rightly upheld the disallowance to the tune of Rs. 0.5% by following the decisions of the earlier years in the case of the assessee wherein the similar issue came up for consideration before the Tribunal and decided in favour of the assessee. Order of CIT(A) upheld.

B)+ assessee has shown the commercial expediency and business needs to advance the loans to the subsidiary company for the reasons that the wind mill installed by the subsidiary company were being used by the assessee for transmission of its electricity to the power greed of the Electricity Board for further distribution and to the ultimate customers. The moment the installation of windmill was completed, the subsidiary company used to pay back the advances received by the assessee by borrowing funds from the banks and other financial institutions. If the assessee uses its interest bearing funds and lent to the sister concern without charging any interest and without charging any interest on the said advances, the advance is liable to be disallowed u/s 36(1)(iii) of the Act. The assessee's business expediency is proved beyond doubt that the entire interest free advances were given to the subsidiary company out of commercial expediency. Interest on borrowed funds cannot be disallowed on the ground that the assessee has advanced interest free loans to sister concern as measure of commercial expediency and what has to be seen is the business purpose and what the sister concern utilization of borrowed the money for business purpose. Order of CIT(A) on this issue confirmed.

C)+ assessee had recognized a loss on account of provisions of Marked to Market losses on forward foreign exchange contract upon re-statement of foreign exchange forward contract at the exchange prevalent at the close or the year or reporting date. Assessee was following a consistent method of accounting to account for the gain or loss on forward contract for foreign exchange as per accounting standard 11 which deals with the treatment of forex losses or gains not actually realized. The same practice was being followed in the earlier year and was also accepted by the Revenue. The need to hedge is a commercial expediency and necessity which is practically followed in all the business houses engaged in the business import/export these days specially when the exchange rate is highly volatile. Therefore, disallowance deleted.

(See 2016-TIOL-451-ITAT-MUM)